David Rolfe Comments on Old Dominion Freight Line

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Sydnee Gatewood
Apr 15, 2021
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Old Dominion Freight Line



(Note: updated from our third quarter 2018 Letter)



We first bought shares of Old Dominion Freight Line (

ODFL, Financial) in the third quarter 2018. Worried over the impact of the unfolding industrial downtown on the trucking industry, we sold the stock shortly thereafter during the second quarter of 2019. That was a mistake. We were correct to be worried about the trucking industry in 2019, but we were very wrong on how resilient Old Dominion's business model would power through the industry downturn in 2019, as well as the Company's exceptional performance during pandemic-laden 2020. Bucking the industry, the Company actually grew earnings per share by +3.8% and +11.4% in 2019 and 2020, respectively. Licking our wounds, we are shareholders once again in this terrific Company.



Old Dominion Freight Line has been a family run business for decades. Old Dominion was founded in 1934 in Richmond, Virginia by Earl and Lillian Congdon, running a single truck between Richmond and Norfolk. The founding year was fortuitous as the U.S. economy was in the early innings of its slow recovery from the Great Depression. The trucking industry boomed during the first half of the 1940s because of new congressional industry regulations and World War II armament spending.



In the early 1950s, Earl Sr. passed, and his wife, Lillian, ran the Company with sons Earl Jr. and Jack. In 1962 Earl Jr. became president. In 1962 the Company moved to High Point, North Carolina. The Company went public in 1991. In 1998, David Congdon (grandson of the Company's founders) was named President and Chief Operating Officer. In March 2018, Greg Gantt, a 24-year Company veteran was named President and COO while David Congdon became Vice Chairman of the Board and CEO.



In the ensuing decades, organic market expansion was complemented by acquisitions of Bottoms-Fiske Truck Line (1957); Barnes Truck Line, Nilsson Motor Express, and White Transport (1969); Star Transport (1972); Deaton Trucking (1979); and Carter and Sons Trucking (2001). Since 2006, trucking and transport assets were purchased from Wichita Southeast Kansas Transit, Priority Freight Line, Bullocks Express Transportation, and Bob's Pickup.



In the early 1980s Congress partially deregulated the motor carriers, granting nationwide operating authority to all applicants. In a strategic move that would emanate for years, the Company extended its services to Florida, Tennessee, California, Dallas, and Chicago, with particular focus on less-than-truckload shipping (LTL).



Trucking companies provide transportation services to virtually every industry operating in the United States and generally offer higher levels of reliability and faster transit times than other surface transportation options. The trucking industry is comprised principally of two types of motor carriers: less-than-truckload (LTL) and truckload (TL).



LTL is used for the transportation of small freight or when freight doesn't require the use of an entire trailer. This shipping method can be used when freight weighs between 150 and 15,000 pounds (think of the United Parcel Service or FedEx, but with much heavier, industrial shipments). When shipping LTL, the shipper pays for the portion of a standard truck trailer its freight occupies, while other shippers and their shipments fill the remaining space.



LTL freight carriers typically pick up multiple shipments from multiple customers on a single truck. The LTL freight is then routed through a network of service centers where the freight may be transferred to other trucks with similar destinations. LTL trucking carriers generally require a more expansive network of local pickup and delivery service centers, as well as larger breakbulk or hub facilities. Over the past few years, e-commerce has become a significant tailwind for LTL shippers.



In contrast, truckload carriers generally dedicate an entire truck to one customer from origin to destination (think of a single truck delivering Colgate toothpaste to a Walgreens distribution center). Unlike TL carriers, LTL carriers require significant capital to create and maintain a network of dense service centers and a huge fleet of tractors and trailers. The high fixed costs and capital spending requirements for LTL trucking carriers make it extraordinarily difficult for new start-ups or small operators to effectively compete with established carriers. In addition, successful LTL carriers generally employ, and regularly update, a high level of technology-based systems and processes that provide information to customers and help reduce operating costs.



The main advantage to using an LTL shipper is that shipments can be transported for a fraction of the cost of hiring an entire truck and trailer for an exclusive shipment. In addition, LTL drivers are typically paid on a per-stop basis and generally drive the same route for long periods with the added benefit that better drivers establish a rapport with customers as well as sleep in the same bed during the week.



Over the past several years, the growth of the U.S. LTL industry has outstripped the overall U.S. trucking industry and transportation industry, in part due to a secular shift towards shorter, just-in-time supply chains, partially driven by the logistical requirements of a larger, fast growing e-commerce industry. Old Dominion has grown faster than the overall LTL market and continues to expand its profitability significantly, relative to competitors, due to its differentiated approach, which we expect will be sustainable.



According to the Company, more than 97% of the Company's revenue has historically been derived from transporting LTL shipments for its customers, whose demand for its services is generally tied to industrial production and the overall health of the U.S. domestic economy. The Company is currently the third largest LTL motor carrier in the United States, as measured by 2019 revenue with 11% of the LTL market. The growth in demand for the Company's services can be attributed to its ability to consistently provide a superior level of customer service at a fair price, which allows customers to meet its supply chain needs. An integrated structure provides customers with consistently high-quality service from origin to destination, and operating structure and proprietary information systems enable efficient management of operating costs.



The Company has been an aggressive investor in real estate and capex. Since 2011, the Company has spent over $1.6 billion in service center additions and center expansions. Over the same time frame the Company's main competitors have not grown their collective service center capacity, while Old Dominion has grown its service center capacity by 14%. The flywheel market share-take effect of the Company's service center capacity and density has driven an increase in shipments per day by +50% to over 43,000 per day since 2011. Its competitor's daily shipments have actually declined by -5%.



As of March 2021, the Company reports that they operate 246 service center locations, of which they owned 229 and leased 17. Their network includes nine major breakbulk facilities located in Atlanta, GA; Columbus, OH; Indianapolis, IN; Greensboro, NC; Harrisburg, PA; Memphis and Morristown, TN; Dallas, TX; and Salt Lake City, UT. Service centers are strategically located throughout the 48 states to provide the highest quality service and minimize freight rehandling costs. The Company recently announced nine new service centers would open throughout 2021. A better measure of the potential productivity of a service center is not necessarily the size (15,000 to 300,000 square feet) but the number of doors at a service center. The table below lists the Company's major breakbulk facilities.



Service centers are responsible for the pickup and delivery of freight within its local service areas. Each night, service centers load outbound freight for transport to its other service centers for delivery. All inbound freight received by the service center in the evening or during the night is generally scheduled for local delivery the next business day, unless a customer requests a different delivery schedule.



According to the Company, as of March 2021, the Company owned 9,288 tractors and 36,650 trailers. They generally use new tractors in linehaul operations (movement of cargo between two major cities or ports, especially those that are more than 1,000 miles apart) for approximately three to five years and then transfer those tractors to local pickup and delivery (P&D) operations for the remainder of their useful lives. In many service centers, tractors perform P&D functions during the day and linehaul functions at night to maximize tractor utilization.



Since 1988, the Company has provided the opportunity for qualified employees to become drivers through the "Old Dominion Driver Training Program." There are currently 3,069 active drivers who have successfully completed this training, which was approximately 30.3% of the driver workforce as of December 31, 2020. Its driver training and qualification programs have been important factors in improving its safety record and retaining qualified drivers. The annual turnover rate for driver graduates is approximately 6.3%, which is below the Company-wide turnover rate for all drivers of approximately 8.0%. Drivers who maintain safe driving records receive annual bonuses of up to $3,000 per driver.



Revenue is generated primarily from customers throughout the United States and other parts of North America with 60% industrial, 25% retail, and 15% residential. In 2020, the largest customer accounted for approximately 4.7% of revenue, and the largest 5, 10, and 20 customers accounted for 15.1%, 21.8%, and 29.7% of revenue, respectively. For each of the previous three years, more than 95% of revenue was derived from services performed in the United States, and less than 5% of revenue was generated from services performed internationally. Note the Company's declining operating ratio over the years in the graphic below. An operating ratio of 85% is the equivalent of an operating profitability margin of 15%. Old Dominion exited 2020 with an industry leading operating margin of 23.7% (76.3% operating margin).



The Company's long-held strategy is to grow capacity and build terminal density to ultimately get closer to its customers. Old Dominion's competitive advantage is its industry-leading, single-integrated LTL hub and spoke network capacity, which ensures 99% on-time delivery on 1 and 2 -day deliveries (70% of its daily shipments). Since 2002, on-time delivery has improved from 94% in 2002 to 99% today. In addition, the Company's cargo claims ratio has declined from 1.5% in 2002 to just 0.1% in 2020. Relatedly, Old Dominion has been awarded the coveted industry Mastio Quality Award as the #1 national carrier for eleven straight years. Hard proof of Old Dominion's competitive advantage is the Company's consistent +600 basis points operating margin advantage relative to its competitors.



Annual network capex is also a Company competitive advantage to ensure industry-leading customer satisfaction. In 2021 capex should reach $600 million $290 million for tractors and trailers and $310 million in real estate and service center expansion. Note: The Company owns the real estate under most of its service centers. Such real estate zoned and purchased over the years is not only literally irreplicable, but extraordinarily valuable today too.



As noted, several of Old Dominion's larger competitors have shrunk their service terminal networks or outsourced shipping capacity to third parties during the past decade. Meanwhile, Old Dominion has continued to expand its network of service centers and owned-and-operated linehaul and P&D tractors. As a result of Old Dominion's consistent, long-term strategy to reinvest in capacity, the Company has substantially less reliance on purchased (third-party contracted) transportation capacity, just as the trucking industry finds itself staring down a long road of labor shortages. Historically, Old Dominion has had a low, single-digit percent of revenues serviced by third party capacity, and a few years ago moved even further away from this reliance. A limited reliance on purchased transportation allows management to focus on maximizing the profitability of Old Dominion's existing capacity, while prudently reinvesting in incremental capacity. The Company's focus on driving returns on owned capacity is a superior long-term strategy compared to chasing market share, especially against the backdrop of a domestic trucking industry facing chronic capacity shortages.



We expect Old Dominion revenues to continue benefitting from the long-term shift towards LTL mode of shipping. Despite continued reinvestment in capacity to meet demand, we expect industry leading operating ratios to continue and help drive an attractive long-term, double-digit growth profile for the Company.



From

David Rolfe (Trades, Portfolio)'s Wedgewood Funds first-quarter 2021 shareholder letter.



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I am the editorial director at GuruFocus. I have a BA in journalism and a MA in mass communications from Texas Tech University. I have lived in Texas most of my life, but also have roots in New Mexico and Colorado. Follow me on Twitter! @gurusydneerg