Old Dominion Isn't Done Yet

| About: Old Dominion (ODFL)
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Earlier this year, I thought the Street's reaction Old Dominion's (NASDAQ:ODFL) fourth quarter results offered investors a good opportunity to buy shares in this high-quality, growing trucking company. Since then, the shares are up about 30% - more than doubling the return of the S&P 500. Although that performance is more mixed relative to other trucking companies- better than Con-Way (NYSE:CNW), but inferior to Arkansas Best (ABFS), YRC Worldwide (NASDAQ:YRCW), and Saia (NASDAQ:SAIA) - Arkansas Best and YRC have benefited from a major catch-up trade and still notably lag Old Dominion on a two-year comparison.

While valuation on the shares has moved up, I don't think the opportunity is over for Old Dominion or its shareholders. The company continues to gain share in the less-than-truckload industry, and I believe the company's combination of service quality, organic growth potential, and strong margin leverage can continue to deliver good returns.

Gaining Share In A Growing Industry

Although 2013 hasn't been a banner year for the American economy, trucking tonnage growth has been pretty solid. As of the most recent data from the American Trucking Association, tonnage growth through August is up about 5% over last year.

Better still, Old Dominion continues to gain share in its less-than-truckload industry. Second quarter tonnage growth numbers weren't all that strong across the sector - FedEx's (NYSE:FDX) LTL tonnage was up about 2% in its most recent quarter, while Arkansas Best's tonnage was up less than 2%, Con-Way was down more than 1%, and YRC Worldwide was down almost 4%. Old Dominion, though, saw tonnage up almost 6% from the year-ago level.

Recent ISM data has been constructive for trucking demand. Likewise, less-than-truckload remains a relatively small part of the national freight market (less than 10%). With its strong service quality (on-time delivery, damage claims, and so on) and ample capacity at its service centers, Old Dominion has the opportunity to grow its LTL business and gain share from less capable rivals.

Pricing Is Staying Strong

Old Dominion is also in good shape from a pricing perspective. The company spooked the Street last week by announcing that third quarter tonnage was going to be about 100bp higher, but that yield (pricing) was going to be about 100bp lower - a situation which had investors worried that the company's earlier price hike wasn't sticking. A few days later, the company explained itself at a sell-side investor conference - core LTL pricing was up about 3%, but a change in service mix in the third quarter was causing the differences in tonnage/yield. As the company's weight per shipment and length of shipment do shift from quarter to quarter, that's an entirely reasonable explanation.

More to the point, pricing seems solid across the industry. Virtually every company in the industry announced higher rates between May and July of this year, with the rate generally between 4.5% and 6%. With rail and intermodal rates also relatively strong, there shouldn't be much pressure on yields unless/until the economy slows further.

Growth, With Leverage

What I like about Old Dominion is the company's prospects for tonnage growth, coupled with better profitability. Old Dominion is still only the fifth or sixth largest LTL carrier in the industry, with a rather wide gap relative to the likes of YRC Worldwide, FedEx, and Con-Way. Moreover, the LTL industry remains highly fragmented, with smaller operators finding it increasingly difficult to stay competitive in terms of technology and infrastructure.

I believe that Old Dominion and not only show above-industry tonnage growth, but an improving mix as well. Relative to Con-Way and Saia, Old Dominion still generates less of its business from overnight and second-day shipments and increasing this ratio ought to be good for yields and margins.

As Old Dominion carries more tonnage, it will make better use of its existing service center network and reap better operating yields. That said, I do have some concerns about whether the company will need to invest more cash in capital equipment to keep up with growth - the company's CSA scores are quite solid relative to others in the LTL industry, but hours of service compliance are worsening, and I do wonder if that means the company needs to add drivers and trucks to handle additional tonnage.

I'm looking for the company to grow revenue a bit in excess of 7% over the long-term, with the mix likely to be relatively even between tonnage and yield growth. Old Dominion's operating ratio is already quite good relative to Con-Way, Arkansas Best, YRC Worldwide, and so on, but management believes it can get even better - the company's adjusted OR was 84% in the second quarter, but management continues to target 83% or better in 2016.

Trucking companies are rarely ever valued on the basis of discounted cash flow, as relatively few companies achieve attractive sustained levels of free cash flow for any significant length of time. Old Dominion doesn't exactly appear cheap on a discounted cash flow basis (with a fair value in the low $40's), but I wouldn't sell or avoid the stock on that basis.

EV/EBITDA may be a more conventional approach to valuing Old Dominion, but it's not without its own challenges. Trucking companies are often valued at 6x to 8x forward EBITDA, but most sell-side analysts are arguing that Old Dominion deserves a higher multiple. With the company's EBITDA forecast to grow by about 15% over the next three years, a 9x multiple (suggesting a $52 fair value) doesn't seem altogether unreasonable.

The Bottom Line

Old Dominion isn't a cheap stock, but the stocks of high-quality companies seldom are. What's more, I do believe that the fundamentals are in place for solid growth in the LTL trucking industry, and that Old Dominion will continue to outperform its peers. I'd be careful about piling in at these prices, but these shares don't often give investors significant pullbacks and this is the sort of company that investors looking for quality growth ideas should want to own.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.