Is Slowing Freight Demand Just A Speed Bump For Old Dominion?

By Stephen D. Simpson, CFA | October 26, 2012 AAA

There are plenty of articles out there declaring the doom of trucking, as railroads and intermodal shipping take away the industry's lunch money (I should know, as I've written some of them). However it's important to remember at least two points. First, not all trucking is the same. Second, not all trucking companies are the same. Old Dominion (Nasdaq:ODFL) continues to demonstrate its credentials for "best trucking company in the biz," but investors could get another chance with this stock if economic uncertainties undermine demand in the fourth quarter.

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Third Quarter Good, but not Great
Old Dominion posted third quarter results that were good, but maybe not as great as some investors may have expected. At a minimum, it looks like this was a more challenging quarter for the less-than-truckload (LTL) industry.

Revenue rose 10% this quarter, as the company married tonnage growth of over 5% with similar yield (pricing) growth. Net of fuel, yield improved a little more than 4%. While that's pretty good in its own right, a nearly 1% decline in average haul length and a slight increase in weight per shipment were both negative for yields. I think it's worth noting that Old Dominion's price experience isn't much different from that at Union Pacific (NYSE:UNP) or CSX (NYSE:CSX), though LTL trucking isn't as vulnerable to rail substitution as truckload carriers.

Old Dominion continues to redefine what LTL companies can achieve in terms of operating efficiency. Operating income rose nearly 19% as the company logged a 110 basis improvement in operating ratio (to 85.1). This was a slight worsening from the second quarter (where the OR was 84.7), but incremental margins were fine when adjusted for a different number of days in the quarter.

SEE: Analyzing Operating Margins

Are Election Year Worries Undermining Business in the Fourth Quarter?
Through this earnings cycle plenty of companies have reported a noticeable decline in business activity. Banks such as U.S. Bancorp (NYSE:USB) have reported seeing less commercial loan demand, while companies in industries ranging from chemicals to semiconductors to transport have reported longer lead times and less activity.

That impacts Old Dominion pretty directly, as less business activity means less need to ship raw materials and finished goods. Take a look at tons per day trends between this year and last - last year saw tonnage growth of 7.9% in July accelerating to 10.5% in October. This year, however, July started off at 8.9%, but growth declined into the low 6%'s for August and September, and management is looking at growth in the 5% range for October.

It's hard to say how much of this is a product of worries about the election or fiscal cliff and how much is just another soft patch in the economy's recovery. Whatever the cause, it is worth pointing out that traffic could be poised to underwhelm in the fourth quarter, and that could be present an opportunity for investors.

SEE: Everything Investors Need To Know About Earnings

Old Dominion Likely to Continue to Shine
Thus far, there isn't much to compare Old Dominion to for the third quarter. Old Dominion's growth was in excess of that reported for the industry by ATA, but that's not really unusual. Likewise, Old Dominion definitely outperformed the LTL businesses at FedEx (NYSE:FDX) and UPS (NYSE:UPS), but that's nothing new either. Interestingly, it does seem like Old Dominion is doing a fair bit better on yields, which may be a little counter-intuitive given the company's smaller size.

With reports coming up from Arkansas Best (Nasdaq:ABFS), Con-Way (NYSE:CNW) and Saia (Nasdaq:SAIA), however, investors won't have too long to wait. Given the challenges seen by Old Dominion, I'd be on the lookout for softer operating ratio performance and some signs of weakness in both yields and tonnage growth.

The Bottom Line
On the basis of a 7.5 times multiple to 2013 EBITDA, Old Dominion looks like a borderline buy/hold right now. I certainly would be in no rush to sell (unless you foresee a major slowdown in the U.S. economy), nor would I rush in to buy today. I do think Old Dominion is the best company in trucking today, but I'd want a larger margin of safety before buying into what looks like it may be a weakening transportation market.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

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