On February 22, 2022, I wrote my most recent article covering one of the most fascinating stocks in the industrial sector: Old Dominion Freight Line (NASDAQ:ODFL). This Thomasville, North Carolina-based trucking company is one of the fastest-growing stocks in the industry as it uses efficiencies to gain market share. Hence, in my article, I made the case for long-term outperformance and dividend growth despite a low yield. The problem was that the valuation was lofty. Hence, a part of my takeaway was:
Unfortunately, the valuation is still lofty after the 20% drop. I expect the valuation to improve as the stock adapts to lower economic expectations. While it’s very hard to predict a good entry price, I hope to add the stock at a price close to $250. That would imply close to 10% more downside. The stock may drop further. If that happens, I will average down.
Right now, the stock is indeed in a downtrend, which is the reason why I’m writing this article. The entire transportation industry (I have a lot of exposure) is getting sold off hard as investors are de-risking their portfolios. As weird as that may sound, as a long-term investor, I’m cheering on the sidelines for investors and traders to sell stocks that make great additions to our long-term portfolios. In this article, I will elaborate on that and explain why I’m excited to finally buy some ODFL.
So, without further ado!
Regular Weakness Is A Blessing
I have roughly 50% of my money in industrial stocks. That sector is home to transportation stocks. In this case, I have a lot (relatively speaking) of money in Union Pacific (UNP), Norfolk Southern (NSC), and Canadian Pacific (CP).
Like everyone, I enjoy capital gains. However, I only ever buy larger positions when stocks are down as I tend to own stocks on a very long-term basis. In other words, it only makes sense to exchange cash for shares when the valuation is right – after all, I don’t really care for mid-term capital gains.
Hence, I absolutely don’t mind it when my stocks are down. However, that’s only possible because I advise people to buy quality stocks. Buying any random stock that never shows any strength isn’t the way to go as long-term capital growth is key.
I used it to give people an alternative for that ETF. It was one of three stocks that I put in “portfolio 1”:
While I will get into the details in this article, we’re once again at a point where slower economic growth expectations are providing us with a better entry.
The quote below shows a part of my view on the economy on April 2:
However, there are some issues. The economy is in a tough place. Economic growth is falling, prices are not. We’re seeing a dangerous mix that could mean stagflation with severe consequences for the consumer while supply chain issues continue to bug industrial companies.
Unfortunately, these risks are now materializing as one of the strongest industries is now being hit hard: trucking.
The Wall Street Journal ran the following headline:
What we’re witnessing is that a tight trucking market is unwinding rather rapidly after trucking was one of the hottest industries since the start of the pandemic. According to the article:
At the same time, freight rates appear to be pulling back from recent historic highs. Prices for last-minute spot loads in the truckload market, which make up a fraction of the market but tend to lead trends in contract rates, are sinking as shipping demand comes closer into balance with available truck capacity. Dry van truckload spot rates excluding fuel surcharges are down 37% since December and 27% in the past month, according to Bank of America Corp. analysts.
“I think it’s fair to say that the days of expecting rate increases are pretty much over,” said Avery Vise, a trucking analyst at FTR Transportation Intelligence. “It’s a question of just how quickly things are going to normalize. The idea that you can just sort of print money is over.”
As a result, we’re seeing some ugly stock price developments in the industry as trucking companies are now underperforming the market. Old Dominion is now down more than 25% year-to-date, which is quite something.
This very poor performance makes total sense as the stock is now following leading indicators like the ISM manufacturing index or the Empire State Manufacturing index, which I used in the graph below. Note the almost perfect correlation between the year-on-year stock price of ODFL and the Empire State Manufacturing index.
Right now, the stock is still positive year-on-year as the graph below shows. However, going forward, the year-on-year performance will slowly drop to roughly -25% as that’s how much the stock is down from recent highs.
As a matter of fact, the ongoing sell-off is one of the most severe in recent history. 2016 was worse with a sell-off of close to 36%. Back then, the world suffered from a manufacturing recession, which did a number on more or less all transportation stocks.
Back then the best buying point was when the ISM index started to bottom slightly below 50. It started an uptrend that resulted in ODFL becoming a 10-bagger. In general, I’m looking to buy ODFL when the ISM index starts to bottom, which was key in building my portfolio in 2020. I bought most of the cyclical stocks I own back then and I’m looking to do it again when the ISM index bottoms. That could be above 50, but I believe it will likely be lower than 50. This could imply up to 10% more downside, which is fine as the worst is already behind us, I believe. Nonetheless, it requires patience, which is why I want investors to keep a close eye on ODFL. Both the ones with existing exposure who want to buy more and the ones who – like me – missed the boat in 2020 and 2021.
So, I’m not going to end this article here as I want to highlight the valuation again, which includes the value this company brings to the table.
So Much Value In ODFL
I sometimes feel like I’m b*llsh*tting when I say that I enjoy both higher and lower prices because it feels like a cheap way out. However, it’s true and it’s what makes long-term investing with the right stocks fun. When stocks go up you end up with capital gains – who doesn’t like that? When stocks go down, you get to buy more at a better valuation and a higher yield, that’s neat, too.
However, in order for that to make sense, we must avoid stocks that miss the boat or fail for any other reason. ODFL is not one of these struggling stocks. The company has consistently grown throughout cycles. In 2023, for example, the company is expected to do $960 million in free cash flow and $2.1 billion in adjusted EBITDA with EBITDA margins coming in close to 33%. That’s up from 20% in 2013.
The company has a $30.6 billion market cap, which implies a free cash flow yield of 3.1% using 2023 expected free cash flow. The company’s dividend yield is just 0.5%, which means that a lot of cash can be used to reduce debt. In the case of ODFL, expectations are that the company can reach $1.1 billion in net cash next year. Net cash is negative net debt, meaning there’s more cash than gross debt.
This means a number of things. One of these things is that dividend growth is looking good. There’s a lot of excess cash and balance sheet health does not need to be addressed as it’s already healthy.
The company initiated its dividend in 2017. Back then, investors got a $0.27 per share payout. In 2021, that number was $0.80. The most recent hike took place on February 2, 2022, when management announced a 50% hike to $0.30 per quarter.
The other thing the company can do with cash is grow. After all, it puts “growth” in dividend “growth” for a reason.
In my last article, I mentioned ODFL’s rapid expansion:
It’s also interesting that the company is outperforming its peers in terms of its service footprint. Since 2011, the number of service centers has increased by 13% allowing for 50% more shipments per day. The only company with similar shipments growth is FedEx Freight (FDX), which is larger and has similar capabilities to expand in a fractured market.
This has resulted in market share gains across the board. In 2010, the company had a market share of 5-7% in most of its operating regions. This has grown to more than 11% in every region. Moreover, in 2002, the company generated 2.9% of sales of the largest 25 LTL carriers. In 2020, this number had grown to 10.3%.
On February 2, the company revealed its 4Q21 earnings, which, once again, have proven the company’s capabilities to deliver strong results. ODFL did $1.41 billion in sales. Up 31.8% compared to the prior year and $30 higher than expected. GAAP EPS came in at $2.41, which is $0.14 higher than expected.
Now, we get to deal with this company at a much better valuation. Using the aforementioned $30.6 billion market cap and $1.1 billion in expected net cash, we get an enterprise value of $29.5 billion. This is 14.0x 2023 expected EBITDA. This valuation has gotten a lot more attractive.
The same goes for the (implied) free cash flow yield of 3.1%, which is one of the highest in recent history.
In other words, the valuation isn’t even lofty anymore despite the company’s ability to penetrate a highly fragmented market. Additionally, if trucking continues to tank, I would not rule out higher spending on acquisitions resulting in an accelerated recovery when growth rebounds.
Trucking used to be red-hot. Now investors are fleeing the scene. Slower economic growth, high inflation, a suffering consumer, uncertainty regarding the Federal Reserve, geopolitical tensions, and other issues are causing economic growth expectations to fall.
Just like prior cycles, it’s dragging down transportation stocks. One of them is Old Dominion Freight Line, one of my long-term favorite stocks in the industry. While (unrealized) capital losses are never fun, I like it when great stocks are offering us new opportunities.
ODFL’s valuation has come down significantly as it adjusts itself to lower economic growth expectations. If history is any indication, ODFL becomes a huge buy if the ISM index starts to bottom. That could indicate roughly 10% more downside, which I believe is fair.
I’m turning neutral on the stock to reflect my economic expectations and urge investors to keep a close eye on ODFL. Please monitor the ISM index (I will continue to update the situation on Twitter and Seeking Alpha) and use it in your favor. I believe that the index will bottom below 50 this year, offering a wide range of new (long-term) investment opportunities.
So, fear not but enjoy the opportunities that will come our way! If there’s one thing that has brought investors wealth, it’s buying ODFL during economic downturns.
(Dis)agree? Let me know in the comments!