Keep on Trucking!
(Guest Commentary by Rick Konrad - January 18, 2007)
For those who had wanted to learn more about picking stocks, evaluating companies, and other issues related to the stock market, we have brought in an additional regular guest commentator, Mr. Rick Konrad for a mid-week discussion. As I mentioned in a previous commentary, Rick will be one of our guest commentators going forward (besides Bill Rempel) and will be publishing a guest commentary on our site during the third Thursday of every month.
In this commentary, Rick is going to discuss the current woes of the trucking industry, and specifically the stock, Old Dominion. Without further ado, following is a biography of Rick:
Rick is author of the excellent investment blog “Value Discipline” and is a regular guest commentator of MarketThoughts (please see “Resolutions for the New Year” for his last guest commentary). Prior to his current role, Rick has been a professional portfolio manager for institutional investors for over 25 years. You can view a more complete profile of Rick on his blog and should you have any questions or thoughts for Rick after reading his commentary, you can also email him at the following address. Rick is a very genuine teacher of the financial markets and treats it very seriously. Case in point: Rick has also been responsible for running the education program for the CFA Society in Toronto (which is the third largest CFA society in the world besides the New York and London Societies) and had also been responsible for grading CFA papers.
Disclaimer: This commentary is solely meant for education purposes and is not intended as investment advice. Please note that the opinions expressed in this commentary are those of the individual author and do not necessarily represent the opinion of MarketThoughts LLC or its management.
The transportation sector for many investors is a trading “playground” that focuses on the highly cyclical feast or famine behavior of airlines. What about the rest of the sector? Is there a longer term investment argument that can be made for other transportation stocks?
Transportation and logistics is a critical element in inventory control for manufacturers and retailers alike. Think of the brouhaha that related to the proposed sale of the U.S. ports to Dubai Ports World in early 2006 or the impact of the last Long Beach strike (or slowdown) demonstrate effectively the importance of this sector.
There are numerous “choke” points that can mess up transportation in the U.S. The top 20 of the nation's 360 commercial ports, handle 80 percent of all imports and exports. Of those 20, the two largest -- Los Angeles/Long Beach and New York -- handle more than 40 percent of all imports.
Don't let the current conditions in this down cycle fool you! Like any other cycle, freight transportation capacity does exceed freight transportation demand at the moment. But this time, the “slack” is not a result of overinvestment in capacity by the industry, the usual culprit in most cyclical industries. Rather, a drop off in demand has occurred. I believe that much of this relates to a significant drop-off in the “heaviest freight” areas, namely automotive demand and housing demand. The consumer's desire for high priced and low volume electronics such as iPods or flat screen TV's does not require a great deal of demand for freight capacity. Finally, given low interest rates, the need for just-in-time inventory practices seems to have been offset by retailer's desire to smooth seasonal shipping flows.
The American Trucking Association (ATA) has indicated that for 2006, industry capacity has remained virtually unchanged, and likely has decreased by 1 or 2%, not exactly the usual cyclical story in trucking.
It seems to me that over the next decade, the U.S. transportation capacity faces a number of constraints. The transportation infrastructure and capacity it needs seems inadequate as consumption grows and trade flows boom. In my view, this is an industry that will be tightening considerably over the next few years. Why? And more importantly, from the standpoint of capital markets, how should we invest?
Some of the constraints are a result of changing regulation. It is expected that the Federal Motor Carrier Safety Administration (FMCSA) is will issue a rule regarding the required implementation of electronic on-board recorders (EOBRs) for the trucking industry. This would eliminate the possibility of falsifying the driver log books that are manually maintained. This would obviously help highway safety issues but reduce industry capacity. Hours of Service rules which limit the number of driving hours are potentially becoming more restrictive. The ATA has also petitioned the FMCSA to limit newly manufactured trucks to a maximum 68 mph speed. Again, a sensible safety measure, but the unintended consequence is to limit the effective capacity of the truck fleet.
Compounding the capacity shortages that regulations evoke, are the well known truck driver shortages. The industry suffers from a shortage of 20,000 drivers currently. Driver turnover, especially for long haul routes has been horrendous at 136% turnover. Short haul routes suffer less, nevertheless, there is small comfort in their 17% turnover.
Demand for trucking follows our increasing consumption and globalization of supply chains. Given the constraints on the supply-side, some normalization of demand for autos and housing could well shift the supply-demand balance much faster than most investors would believe. I suspect that pricing in the industry will holdup much better than most investors believe. Shippers, I think, barring a major recession, will be reluctant to pressure their important logistics suppliers when crisis looms, even though demand at the moment may be less than robust.
Some of the truckers have been particularly poor performers. Old Dominion (ODFL) has under-performed the S&P 500 by 30.6% in the last six months. Valuations reflect some pretty dire circumstances. ODFL trades at 6.4 times EBITDA and 9.7 times EBIT.
Here are some valuation stats provided by Reuters: ODFL
Old Dominion Freight Line, Inc., headquartered in Thomasville, NC, provides regional, inter-regional, and national less-than-truckload service for five regions in the U.S. The company provides full-state coverage to 33 of the 44 states that it serves directly within the Southeast, South Central, Northeast, Midwest, and West and provides service to the remaining states through marketing and carrier relationships. Old Dominion provides its services through a network of 138 service centers and a fleet composed of about 3,400 tractors and 13,000 trailers.
ODFL is quite unique with what in my opinion is the best historical record of the LTL truckers. Its unique blend of regional and inter-regional services that are fully integrated under one umbrella, allow it to compete very effectively. The regional carriers are incapable of handling the longer-haul inter-line business, giving ODFL a competitive advantage with larger shippers. Smaller carriers lack the ability to provide a complete package of services, and unlike ODFL, cannot self-insure.
ODFL is completely non-union. It has a rather unique customer base compared to other truckers. About 45% of ODFL's business is manufacturing/industrial (with almost no auto or homebuilding), 25% retail, 8% food, 4% medical, and the rest being miscellaneous freight.
Despite what superficially appears to be a commodity business, ODFL appears to be building franchise value. By expanding geographically, building its soon to be nationwide network, by increasing the density of its service within its existing lanes, by augmenting its service to provide more value added services, the company should have the ability to maintain prices and improve margins in what has been viewed as a tough business environment.
Disclaimer: Neither I, my family, or clients own a current position in ODFL.