Old Dominion (ODFL) was brought to my attention by readers of one of my previous articles. I decided to do some due diligence and now I wish I heard about this company sooner.

Just a brief background on the company, Old Dominion is a leading “Less-than-truckload” or “LTL” company. The company is the 3rd largest of its kind in the US and in the past five years has increased market share primarily through organic growth. LTL has historically made up roughly 97% of the company’s revenue despite providing ancillary value-added services such as truckload brokerage and supply chain consulting.

Investment Thesis 1: Large Economic Moat due to Network effects

There are predominantly two types of carriers in the trucking industry – LTL and truckload. Truckload carriers would dedicate an entire truck to a single customer. The truck would then carry the customer’s goods from point A to point B. An LTL freight carrier, on the other hand, picks up multiple freights from multiple customers at multiple locations. Think of it as like an “UBER pool” (UBER) but for freight.

The advantage for the customers is that if you don’t have enough freight to completely fill a truck it makes more sense to “split the space” with another customer. This lowers the overall costs for a customer as they don’t need to buy space they won’t use. This arrangement also has advantages for LTL companies like Old Dominion as they can charge a bit more for the used space. Think of it like UBER pool where the individual pays less compared to a normal UBER, yet all the pool participants in aggregate pay more.

I’ve done research previously on the trucking industry for another article. For truckload companies, the competitive advantage comes from having the scale to drive costs lower. For LTL companies the scale advantage works a little differently as it becomes important to reach scale in order to develop their network of service centers. These service centers act as drop-off and pick up points where freight can also be transferred to other trucks heading the same direction. An LTL company like Old Dominion needs a deep network of service centers in order to make the business model work. This network forms the company’s competitive advantage and economic moat.

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Compared to a trucking company where anyone can buy a truck and deliver goods from point A to point B, albeit at a much higher cost if you don’t have the scale. It is more difficult to enter the LTL industry. Because of this, companies like Old Dominion can earn excess returns on assets and the end result is that national LTL is dominated by a handful of firms namely FedEx (FDX), UPS (UPS), YRC Worldwide (YRCW), and XPO Logistics (XPO). The only company I can see entering this space and disrupting this market is Amazon (AMZN) which is a key risk for incumbents like Old Dominion.

Investor presentation

Investment Thesis 2: Old Dominion is well-run with a non-union workforce

Even among LTL Carriers, the company looks good with regard to operational metrics. The company’s cargo claims as a percentage of revenue was down to around 0.25%. On-time deliveries as a % of total was close to 99% in 2019. The company has been consistently growing market share in all markets and the majority of these gains stem from organic growth.

Investor presentation

The company has a good relationship with employees and has remained union-free. Not having to deal with the headache of a union is a huge competitive advantage for Old Dominion. LTL companies represented by unions have been losing market share over the years. In 2002, LTL companies with unions had a market share of 45%. This dropped to 25.9% in 2019. In logistics and operations, it is of absolute importance to keep work disruptions to a minimum. In fact, the Teamsters union can be partially attributed to the near-collapse of YRC Worldwide (NASDAQ:YRCW) back in 2010 and has been a source of excessive costs since.

Investor presentation

The fact that the company is well-run, union-free, and has a particularly deep network (see investment thesis one) has led Old Dominion to earn returns well in excess of its peers. The company’s Return on Assets (ROA) absolutely blows out its industry peers. UPS, XPO Logistics, and ArcBest subsidiary, ABF Freight are all represented by Teamsters Union.

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A key risk for Old Dominion though is a Biden presidency with Labor secretary Bernie Sanders. A tireless advocate of unions, Sanders might be tempted to push for legislation or enact guidelines that fundamentally change the employee-employer relationship.

ChartData by YCharts

Investment Thesis 3: Old Dominion has a pristine balance sheet and is firing on all cylinders

The final bullish point for my investment thesis on Old Dominion is that the company has a pristine balance sheet. The company has more cash on its balance sheet than long-term debt. The company has cash and short-term equivalents of $625.6 million vs. long-term debt of $99.9 million. The company has Total Assets of $4.27 billion and most of these assets are “real assets” as the company only has goodwill and other assets of $19.4 million and $180.2 million, respectively. As some of the company’s competitors struggle with crushing debt, the company can focus on delivering superior value and thus gain market share.

In Q3 2020, the company’s Operating Ratio hit a Company Record of 74.5%, leading to a massive 23% increase in Net Income despite revenues remaining flat. YTD revenues are down 5.1% yet Net Income was up 2.4% due to this increase in margins and efficiencies.

The strength of our financial results reflects the remarkable recovery in the domestic economy as well as the continued execution of our long-term strategic plan that focuses on providing superior service at a fair price. Demand for our industry-leading value proposition continues to improve, and we will continue to invest in the three key elements of our capacity – people, equipment and service centers – that will support our ability to win market share over the long term

CEO statement Q3 2020 results

The company has started returning its excess capital back to shareholders via a repurchase program, started in May 2020, to repurchase $700.0 million worth of stock. The company’s balance sheet well supports this proposition though the company did not repurchase any stock in Q3 2020.

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Conclusion

The company is trading at a premium valuation to its peers but I believe that is well-deserved. The company is trading at a forward P/E of 36.2x. The company has practically zero debt, earns a return well in excess of its peers, and is still growing market share. While the argument can be made that the positives have been priced in, this isn’t a particularly bad price to own the stock given the current interest rate environment. I always default to buying a wonderful company at a fair price. I have Old Dominion as a buy.

Key Risks

While I do like the company, as mentioned above, there are a few key risks to my thesis. First is that the company is trading at a premium; therefore, a lot of positives may have already been priced in. The stock may drop if the company misses earnings. The second, more worrying risk is that employees of Old Dominion could come together and decide to form a union. A Biden administration could be more pro-union and either enact legislation to make this a requirement or encourage/ make it easier for employees to form unions. Having to deal with an employee union could increase the labor and administrative costs for Old Dominion.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in ODFL over 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.

Additional disclosure: Caveat emptor! (Buyer beware.) Please do your own proper due diligence on any stock directly or indirectly mentioned in this article. You probably should seek advice from a broker or financial adviser before making any investment decisions. I don’t know you or your specific circumstances, therefore, your tolerance and suitability to take risks may differ. This article should be considered general information, and not relied on as a formal investment recommendation.



Via SeekingAlpha.com