Old Dominion Freight Line Is A Beast
- ODFL has added almost 40% since my January 2021 article thanks to high demand and its ability to generate value.
- The company remains in a good place despite a challenging labor market and fierce competition.
- Unfortunately, the valuation is lofty and its dividend yield is low, which means investors will have to make choices with regard to their investment timing.
In January of this year, I wrote my most recent article covering one of the most fascinating transportation stocks in the United States. The North Carolina-based LTL trucking giant Old Dominion Freight Line (NASDAQ:ODFL) is a fantastic dividend growth stock as I discussed in January. In this article, I will reiterate that call as the company has blown it out of the water. The company just beat its 2Q21 earnings, approved a massive buyback program, and rewarded investors with YTD capital gains of nearly 40%. On top of that, the company might be a good example of why long-term investors should just buy good stocks even if the valuation seems to be lofty. So, bear with me!
Dividend Growth With A Capital G
The Old Dominion Freight Line is a beast for many reasons. The most important one is its ability to generate value for its shareholders. Over the past 10 years, investors have benefited from 1,530% in capital gains. The total return was 1,560% as the company's first dividend was initiated in 2017. This return is blowing the S&P 500 out of the water - it isn't even close. Since the early 1990s, ODFL has returned more than 15,000%, which beats anything except a few high-growth tech stocks and a few others.
While the company is operating in an extremely competitive LTL (less than truckload) trucking industry, it is now generating significant free cash flow ("FCF"). If you're new to this, think of FCF as the kind of cash the company can spend on dividends, buybacks, and debt reduction as this is after the company has invested in capital goods ("CapEx") like new trucks, buildings, and related. In this case, the company has seen a massive increase in FCF. In the years after the Great Financial Crisis, FCF was hovering close to $50 million. This changed as the company expanded its technological capabilities and footprint in the United States. It also helped that the pandemic massively accelerate e-commerce as it boosted FCF from $500 million in 2019 to more than $700 million in 2020.
Source: TIKR.com (Includes 2021/2022 expectations)
To give you a better understanding of these FCF numbers, imagine if the company spent all of its free cash flow on dividends next year (roughly $750 million). We can assume that because the company has negative net debt, which means there is no need to further improve its balance sheet). In this case, $750 million is roughly 2.4% of the company's $31.1 billion market cap. That free cash flow yield is way above the company's 0.3% dividend yield, which means that ODFL has a lot of room to grow its dividend on a long-term basis. Currently, dividend payments are less than $100 million on an annual basis.
With this in mind, dividend growth will be gradual. It will be very high, but there is no way the company hikes its dividend by i.e., 200% in a single year just because FCF is high. For example, in February, the company hiked its dividend by 33.3%, which makes more sense as companies like to keep dividend growth consistent. Also, unlike buybacks, dividends are more rigid, meaning a company's dividend isn't a tool to return excess free cash flow to shareholders. That's where buybacks come in. Buybacks are very volatile as the company can use (accelerated) repurchase programs to reward investors on a short- and mid-term basis. Buybacks aren't attached to a commitment and most investors aren't 'angry' when buybacks are halted in times of economic weakness. Dividends on the other hand are a different story. That's why dividend growth will be gradual but we won't see a 2.4% yield anytime soon. So, if you need a high yield, you will be highly disappointed that ODFL offers a 0.3% yield. Even if it doubles, you still don't make more than 0.6%.
Hence, the focus is on buybacks.
As the graph below shows, dividends are just a minor part of cash distributions. Most of the free cash flow is spent on buybacks. I would do the same if I were the ODFL CFO based on the aforementioned reasons. On July 28, the company approved (or at least revealed) a $2.0 billion buyback program that will begin after the completion of the existing $700 million buyback program (roughly $206 million remaining under the program). This means that ODFL will repurchase roughly 6.4% of shares outstanding based on its current market cap. That's a huge deal.
Source: ODFL Investor Presentation
With that said, what's next?
ODFL is a perfect example of why investors (especially younger investors) with a long time horizon should sometimes just ignore valuation (within reason). Since my bullish article in January, the stock has returned more than 40%. So even if we get a 10-15% drawdown, I (and others) would still be buying way above January 2021 levels.
One of the reasons for this is because ODFL is in a fantastic spot. While the entire industry is struggling to hire employees, ODFL can operate its business very efficiently. Between March and June, the company hired an additional 1,100 employees. In the third quarter, another 1,000 employees will be hired. That's something smaller trucking companies cannot compete with.
Even prior to the pandemic, ODFL expanded its market position from 2.9% in 2002 to 10.2% in 2019. In most markets, the company has almost doubled its market share since 2010. That's a great achievement and I do not believe that this will change anytime soon. Especially not in this economy.
Source: ODFL Investor Presentation
It also helps that the company is increasingly efficient. Since 2011, the company has lowered its operating ratio (how much it costs to run its business in % of total revenues) from close to 90% to roughly 77%.
As a result, we're looking at 26.7% full-year sales growth in 2021, followed by another expected surge of 8.7% next year. EBITDA is expected to soar by 31% this year and 11% next year - backed by 31%-ish EBITDA margins, which is more than 500 basis points higher compared to pre-pandemic years.
Source: TIKR.com (Includes 2021/2022 expectations)
In terms of valuation, this means we're dealing with an expected enterprise value of roughly $30.3 billion based on a $31.1 billion market cap and close to $800 in expected net debt in 2022. That's roughly 17.2x next year's expected EBITDA.
That's certainly not cheap, but it's also not a deal-breaker.
My strategy remains to wait for weakness. Why? Haven't I learned my lesson? That's based on the fact that 48% of my exposure is already in industrial stocks. Most of it is in transportation-related industries like railroads (overweight) and aerospace. In other words, from a risk-management point of view, it wouldn't be the best thing to add even more to that before buying stocks in other industries.
I will continue to treat ODFL as a wild card and buy it when stocks take a bigger hit. Right now, I am seeing rising macro risks related to peak economic sentiment and the ongoing pandemic - and measures to combat it - as I explained in this blog. That's also will I will give the stock a neutral rating.
I wouldn't bet against a 10-15% drop in the S&P 500 in the mid-term. If that is the case, I happily add ODFL to my portfolio.
ODFL is a fascinating company. Management has figured out a way to thrive in a highly competitive trucking industry by offering top-tier services in all regions of the country. The company has a relatively low operating ratio and the ability to access new drivers in a market that crushes smaller players due to the ongoing labor shortage. I have little doubt that the company will continue its growth streak - including gaining a higher market share.
The problem is that the company's dividend yield is low. Even if I expect that high dividend growth will come with a lot of capital gains, income-oriented (retired) investors might need a higher yield now instead of 10 years from now. Also, because I'm already overweight industrials, I will once again take my chances to wait for a meaningful correction. It comes with a risk, but I'm willing to take that risk.
(Dis)agree? Let me know in the comments!
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