It’s a company with a lot of green spread around its financial strength and profitability tables. But the valuation ratio is in the dumps. What is a value investor to think?
The company is Old Dominion Freight Lines Inc. (ODFL, Financial), one of the biggest trucking companies in the United States. More specifically, it is a less-than-truckload carrier, hauling for customers that don’t have loads big enough to fill a freight-truck trailer.
As such, it competes with companies such as FedEx Freight (FDX, Financial) and UPS Freight (UPS, Financial). Old Dominion has reported it is the third-largest carrier in the nation by revenue, but doesn’t specify which companies it trails. My research indicates the two larger competitors are FedEx Freight and YRC Worldwide (YRCW, Financial). There are also thousands of smaller competitors, especially in local and regional markets.
As an LTL company, it has high fixed costs, not only for trucks but also for the real estate and service centers it needs.
To handle such fixed costs, a company needs one or more of these three components: strong earnings, strong cash flow or a heavy debt load. The financial strength table above suggests Old Dominion does not have much of a debt load.
This chart shows how the remaining two components, earnings per share and operating cash flow per share, had grown in the 10 years prior to the end of 2019:
Now, contrast that with the 10-year long-term debt and capital lease obligations chart (there are no capital lease obligations, so the chart refers to only long-term debt):
What we are seeing is a company that has taken an ax to its debt load, while growing its earnings and operating cash flow. Given that the 2010s have been a decade of low interest rates, Old Dominion has resisted the lure of leverage and cleaned up its balance sheet.
That’s the kind of management value investors like to see, but will the company hold up to further scrutiny?
Since Old Dominion is a Buffett-Munger Screener stock, we can evaluate it using the four criteria required to reach Buffett-Munger status: predictability of revenue and earnings growth, a competitive advantage, little or no debt and a PEG/PEPG ratio showing the stock is undervalued.
Predictability
Old Dominion receives a four out of five-star rating for predictability. This chart shows revenue per share and earnings per share for the 10 years ending Dec. 31, 2019:
Can it continue to grow in the intensively competitive trucking industry? It should be able to; as it noted in its May investor presentation, it is investing significant sums back into its business:
Competitive advantage
One measure of competitive advantage is found in the margins; a company with consistent and significant margins can maintain or even grow its prices. As this chart shows, Old Dominion has grown its operating and net margins:
For another perspective, we can look at a trucking industry metric, LTL revenue per shipment, from the investor presentation:
Debt
This slide shows its long-term debt (green bars) in relation to the company’s return on invested capital (ROIC):
At the end of 2019, Old Dominion had zero short-term debt and just $45 million in long-term debt.
Valuation
So far, the fundamentals have been attractive, very attractive in some cases. However, that changes when we turn to valuation:
- The PEG ratio, which is the key for Buffett-Munger stocks, is 1.98%, well above the undervalued and fairly valued ranges. The ratio is calculated by dividing the price-earnings ratio (30.86) by its five-year Ebitda growth rate (15.60%).
- The price-earnings ratio routinely swings up and down because the trucking industry reflects the ups and downs of the American economy. Currently, Old Dominion is at a high point:
- Finally, the discounted cash flow calculator shows it to have a negative margin of safety of 8.4%.
Gurus
Ten of the investing gurus followed by GuruFocus have positions in this stock. Largest among them is PRIMECAP Investment with just under 302,000 shares, after increasing its stake by 13.54% in the first quarter.
Jerome Dodson (Trades, Portfolio) of the Parnassus Fund has the second-highest accumulation, holding 148,537 shares, while Pioneer Investments (Trades, Portfolio) is third with 55,307 shares after unloading 16.83% of its holding in the first quarter.
Conclusion
Given its relatively high predictability for growth, its competitive advantage and its low level of debt, Old Dominion Freight Lines would be an excellent target for many investors.
But the current price is rich and overvalued by all the metrics we reviewed. And perhaps that’s not surprising, given the amount of growth we are buying. And this a well-managed company that has mapped out a future with more growth and would be hard to ignore.
As the chart of Old Dominion’s price-earnings ratio suggests, this is a cyclical company and is likely to provide a better entry point in the next few years.
Disclosure: I do not own shares in any companies named in this article and do not expect to buy any in the next 72 hours.
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