Less than truckload (aka LTL) transportation company Old Dominion (ODFL) did something last week that it doesn't do often - it disappointed the Street and saw some margin erosion. Weather seems to have been a major contributing factor, though, and the company continues to show significantly better tonnage growth than its peers, while hauling that freight much more profitably. Old Dominion isn't exceedingly cheap, having risen another 15% since my last write-up, but it is still slightly undervalued and still an excellent stock for the long term.
Q4 Results Hit Some Ice
Old Dominion didn't have a terrible fourth quarter, but for a company with such a strong operating history it was an unusual report.
Revenue rose 11%, which was basically in line with expectations. Pricing (ex-fuel) was a little sluggish, growing 1%. Tonnage growth remains robust, though, and ODFL's 11% growth here in the fourth quarter suggests that the company continues to gain share in the LTL market.
Operating expenses were up almost 11%, and that was more than expected. Insurance claims jumped 27% (more than $1.5 million) and while not a large part of reported expenses, it is important to watch as damaged shipments can lead to lost business. More significant in terms of the operating miss were the 16% increase in purchased transportation and nearly 15% increase in salary and benefit expenses. Severe winter weather played a role in the higher costs, but changes to Hours of Service rules also played a role (and will continue to have an impact).
With all that, operating income rose 14% for the quarter and the operating ratio only improved by 40bp from the year-ago level. Compared to the third quarter, though, operating ratio worsened by three points and the incremental operating ratio worsened almost 10 points.
Disappointment Is A Relative Concept
By Old Dominion standards, this wasn't a great quarter. A lot of other LTL carriers would be happy to have this kind of "disappointment" to show to their shareholders.
Con-Way (CNW) reported better pricing growth (above 1%), but just 1% tonnage growth and 20bp of improvement in operating ratio, and that operating ratio (97.2%) is much, much higher (and that's a bad thing, as operating ratio is basically the inverse of operating margin). Arkansas Best (ABFS) likewise saw better pricing, but tonnage growth was 3% and its operating ratio is likewise in the high 90%'s (98%).
Given Old Dominion management's talk of better than 11% tonnage growth in January and an expectation for 10% to 11% growth in the first quarter, it looks like the share gains are going to continue. Pricing is certainly an unknown, though spot prices have been improving in ground freight. Better pricing would certainly be welcome, but I wonder if some of this is structural or weather-related - Old Dominion lags carriers like Con-Way and SAIA (SAIA) in terms of the percentage of shipments delivered in two days or less and the weather issues in the fourth quarter likely didn't do them any favors in building the more lucrative faster delivery share.
Hours Of Service Taking Their Toll
As I mentioned earlier, new hours of service rules are having a negative impact on Old Dominion's profitability. The U.S. Department of Transportation requires truck drivers to take a mandated amount of time off during a week, and a recent change requires both a 30-minute break in every eight-hour period and only allows one restart per week, with each 34-hour restart including two periods between 1am and 5am. In essence, this rule requires drivers to take two days off.
While the government claimed that the change would only impact around 15% of all drivers, industry surveys have suggested that has many as half of drivers are seeing lower earnings as a result. In the case of Old Dominion, the company had many city drivers that would drive Monday-Friday and then take an extra trip on the weekend or a little extra money. That is no longer an option, and Old Dominion has had to hire additional drivers to cover as many as 250 dispatches on the weekend - and adding those part-time drivers also adds inefficiency to the overall system.
Investing To Stay Ahead
Management did guide to a higher-than-expected capital spending budget for 2014, but trucking companies aren't really valued on the basis of their free cash generation (at least not in the short term). More to the point, I think Old Dominion is investing for further growth by allocating more than 10% of the budget (and close to $40 million) for various technology upgrades. Whether it is for monitoring rates, coordinating shipments, or otherwise maximizing the efficiency of the fleet assets, technology is a significant edge for Old Dominion and I'm glad to see the company investing at a time when many of its rivals are desperately trying to get their operating costs under control (let alone thinking about/investing for the future).
Why does the technology matter? Handheld computers allow the driver to capture real-time info on pickup and delivery (including number and weight of pieces), allowing the Descartes routing system to consolidate route and prioritize shipments before the driver even finishes at the site. RFID tags and a barcode-based dockyard management system further allow for real-time remote tracking of freight and assets, sparing paperwork and live check-ins with offices. Management has previously estimated that they save more than $0.50 per freight bill with these systems, not an insignificant sum when you consider that Old Dominion carries more than 2 million shipments a quarter.
Along those lines, I would note that YRC Worldwide (YRCW) does seem to have made some meaningful progress in getting its affairs in order. As I assumed would happen, the company found a way to negotiate a deal with the Teamsters on labor cost cuts, and management has been using that newfound labor stability to refinance its outstanding debt. I never thought it was likely that YRC Worldwide was going to go under, so this does not change my outlook on Old Dominion. If anything, the struggles of major carriers like YRC Worldwide and Arkansas Best may usher in some added responsibility and discipline to the sector, which would probably serve Old Dominion even better.
A Story Still Driven By Share Growth And Margins
I continue to see significant market share and revenue growth potential for Old Dominion. Intermodal transportation is more of a threat to truckload carriers than to companies like Old Dominion and I believe there are significant opportunities for the company to expand its service offerings and grab business on the basis of higher/better service levels.
With that, I believe Old Dominion can grow revenue at a long-term rate in the high single digits. I expect free cash flow growth to significantly outstrip revenue as the company leverages past investments in service centers and other infrastructure, but it is worth remembering that trucking companies are seldom valued or traded on the basis of FCF models.
The Bottom Line
Maintaining my prior 9x forward EBITDA multiple leads me to a fair value of $55 for Old Dominion shares. That's not major undervaluation, but I wouldn't expect a leading operator like Old Dominion to be trading at a bargain. Better economic growth in the U.S. in 2014 would be a positive for the shares, but I would argue that this company is still at a point in its life where long holding periods can still work out well for investors.