Double-Digit Growth Continues To Propel Old Dominion

Summary

• Old Dominion is prospering as freight demand expands, with above-average tonnage growth, healthy pricing, and ongoing margin leverage.
• Management seems steadfast in sticking to what it does best; there are attractive growth opportunities for Old Dominion even without a clear pivot toward home delivery and other e-commerce niches.
• Old Dominion's shares seem to be pricing in low-double-digit EBITDA growth; a reasonable expectation, but not one that seems to offer a lot of risk-adjusted upside.

Forget its top-level performance in the less-than-truckload (or LTL) sector, Old Dominion (NASDAQ:ODFL) is one of the better-run companies I've followed for the past decade-plus. Management sticks to what it does best, doesn't jeopardize the model just to please Wall Street in the short term, and continues to build the business for further growth. The only issue with that top-level performance is that it is no secret and Old Dominion's shares are seldom cheap outside of those cyclical downturns where the outlook for the sector is bleak.

Today is the opposite; demand for freight is expanding and Old Dominion is once again demonstrating that it can win share with service quality during such expansions. The shares are already pricing in double-digit EBITDA growth, and I think outperforming those expectations is going to be difficult. While I'd be very slow to sell Old Dominion if I already owned these shares, it's tough for me to argue for it as a buy at today's valuation.

The Trucks Are Rolling

Old Dominion has always been more skewed towards industrial and non-retail freight, and the economic expansion in the U.S. has fueled a sharp recovery in tonnage growth. From a year ago (the fourth quarter of 2016), quarterly year-over-year tonnage growth has improved from basically no growth to over 2%, to 6%, to 7%, and most recently to over 14%. Both weight and volume are growing and pricing growth has strengthened from the low single digits to the mid-single digits.

Old Dominion's growth isn't just the byproduct of a stronger overall market. In fact, many of its peers aren't reporting especially exciting tonnage numbers. Saia (SAIA) recently reported over 8% tonnage growth, but ArcBest (ARCB) saw a 5% contraction, while YRC Worldwide (YRCW) reported slight contraction in its Freight business and 4% growth in its Regional business and XPO (XPO) reported just under 3% tonnage growth in its trucking business.

Long a leader among its LTL peers in profitability, Old Dominion has continued to find ways to expand profitability. The company's operating ratio (the inverse of operating margin) dropped below 81 in the second quarter to a new record, and even though the operating ratio subsequently increased in the third and fourth quarters on a sequential basis, the fourth quarter still saw a two-point year-over-year improvement despite paying significant employee bonuses after the passage of the new tax bill.

While wages have grown modestly as a percentage of revenue over the last few years, Old Dominion's overall expense leverage remains attractive. One of the positives working in Old Dominion's favor during expansionary periods is its ability to handle its own line-haul needs, reducing its exposure to growing purchased transportation costs.

What Comes Next?

Old Dominion is what it is - management has created a model and an operating footprint that works extremely well, and it is reluctant to change. To that end, Old Dominion is not following peers/rivals like XPO or FedEx (FDX) further into home delivery and ecommerce-related business. Given the tonnage growth Old Dominion is seeing, it's not exactly hurting it.

What's more, just because Old Dominion isn't targeting those parts of the ecommerce opportunity, that doesn't mean it doesn't have leverage to the trend. Old Dominion's superior IT-driven system is suited to expediting, a $5 billion market growing considerably faster than GDP, and Old Dominion is likewise benefiting from an ecommerce-driven change in shipping that is seeing business once handled by truckload shippers (from factories to large distribution centers) go toward LTL shippers. Old Dominion is also well-suited to growing third-party logistics opportunities and ongoing adoption of just-in-time inventory management practices.

Old Dominion is also poised to benefit from overall share growth. Expedited shipping and just-in-time logistics require high service levels, including reliable on-time performance and low damage claims. Old Dominion continues to lead in these metrics (99% on-time, sub-0.3% claims), though Saia is at least in the neighborhood. There's still slack and underused capacity in Old Dominion's network, as well as the opportunity to add additional service centers in under-penetrated geographies.

The Opportunity

I don't think Old Dominion can maintain its trailing growth rates, but I do expect the company to continue to gain share in the LTL space and benefit from overall growth in LTL volumes. I also believe the company can find additional sources of operating leverage, but not to the same extent as in the past. With that, I think EBITDA growth will slow from its trailing mid-teens rate into the low double digits.

Valuing trucking stocks on DCF seldom works (and when it does, it tends to be when the cycle is near a low), but even an EV/EBITDA approach doesn't appear to offer a lot of upside today. I don't mind paying above Old Dominion's historical average EBITDA multiples, but I think today's price already factors in low-double-digit growth in EBITDA and cash flow.

The Bottom Line

Like I said in the beginning, I think Old Dominion is an uncommonly well-run company that can still outgrow its market by a meaningful amount. I also believe investors should be slow to part with the shares of exceptional companies, as good companies often get (and deserve) premium valuations. I also don't believe in paying any price for quality, though, and I don't see the prospects of earning above-average returns here as very likely. With that, I'll wait for the sector to slow again (as it assuredly will) and reconsider the shares when the Street's enthusiasm has cooled.

Analyst’s Disclosure: I/we 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.