One Trucking Name to Buy, Two to Sell

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Improving fundamentals for the trucking industry have attracted a lot of attention from investors. Favorable market dynamics are at play that support improving returns and mid-teen earnings growth on the back of incremental margin expansion from modest tonnage growth, pricing gains, and relatively benign unit costs.

However, this theme does not present a straightforward investing idea. Within the trucking industry, we have two main types of players: asset owners and truck brokers. The question is: Which is better exposed to improving fundamentals?

The difference

For those who haven’t been following the trucking industry you might not have an idea about the difference between these two types.

Asset owners like Old Dominion Freight Line (NASDAQ: ODFL) own their own trucks which are used for transportation purposes.

On the other hand, incumbent truck brokers do not own trucks; they just earn commissions by connecting self-employed truckers who own trucks with shipping customers. Prime examples of pure-plays on this model are Landstar (NASDAQ: LSTR) and C.H. Robinson Worldwide (NASDAQ: CHRW). There are many other truckers like J.B. Hunt and Knight Transportation that have both asset-based truckload shipping segments and  non-asset based truck brokerage segments.

In these circumstances, common sense suggests that asset owners, by the virtue of owning their own trucks, will outperform the truck brokers given that they are more operationally leveraged to the industry cycle which is in its early stages. Moreover, truck brokers face ongoing competition from new entrants which are hampering pricing and dampening earnings growth for them.

Apart from that every company has its own secular growth/decline story. Let’s have a look at it:

The top pick in the trucking sector

For many analysts out there at the Street, Old Dominion is believed to be the best company in the trucking industry.

The stock is currently operating at a multiple of 20 times earnings. Though this seems expensive, but the multiple is justified given the strong upward momentum in the company’s margins. Not only this, many believe that the company is poised to improve its profitability given that it is experiencing increased density across its network by gaining share from peers. Moreover, the company has been focused on inward retained earnings rebuilding by adjusting its cost structure while trying to raise prices. This can also mean favorable re-rating of stock’s multiple.

Which truck brokers to lose?

As already mentioned, the truck brokers are expected to under-perform given high level of competition in the market. Landstar and CH Robinson are expected to lose the most.

Landstar’s First Quarter of 2013 (1Q13) earnings performance met reduced expectations but management’s soft guidance for 2Q Earnings Per Share (EPS) was  short of the consensus estimates by 8-10%. The Street has reduced 2Q13 expectations for load growth to -1.0% from +2% given management’s commentary on April volumes. Moreover, muted expansion of the sales agent pool, a key driver of incremental revenue opportunities, will likely temper revenue growth. The more modest top-line assumption leads to slightly lower operating margins. The margin expansion estimates in 2014-2015 have been toned down to 100basis points(bp)/40bp, from 160bp/80bp.

Historically, in such circumstance, CH Robinson was able to pass along higher freight rates to shippers but that has changed since 2007-2008. Currently, the stock is down 13% for the year. There have been a few reasons why the stock price of CH Robinson has languished:

1) EPS growth has moderated from mid teens to high single digits.

2) Net revenue margins have been trending lower since 2009

3) Concerns that the model is broken remain a hot topic; Many believe that the broker model is no more profitable. However, Goldman Sachs believes that the model is not broken – it is just that the industry is facing lower margins due to increased competition from new entrants as well as existing trucking companies diversifying into truck brokerage; e.g. JB Hunt

Final word

Improving fundamentals in the trucking industry have provided investors with yet another investing option. However, not all truckers are expected to benefit from the situation: truck asset owners are expected to outperform truck brokers. Old Dominion remains the best name in the industry. 

Zain Abbas has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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