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Morningstar | Old Dominion’s 3Q Operating Margins in the Fast Lane; Shares Still Looking Rich

In the third quarter, less-than-truckload carrier Old Dominion posted strong 21% top-line expansion (22% year to date) thanks to the highly favorable operating backdrop in terms of freight demand and pricing conditions. Margins, in particular, surpassed our expected run rate for the year as robust tonnage and yield gains continued to strengthen the firm’s already-impressive lane density. That said, since our midcycle revenue and margin assumptions remain mostly intact, we don’t expect to materially alter our $94 fair value estimate.

We expect a highly favorable environment for LTL carriers to persist for the remainder of 2018 and into the first half of 2019, as capacity will probably remain somewhat tight in the full-truckload, or TL, sector due to the impact of widespread adoption of electronic logging devices among small carriers this year (mandatory as of December 2017). LTL market capacity isn’t as constrained as the TL market, but large LTL carriers like Old Dominion have been benefiting from TL spillover freight, as occurred in 2014-15, along with a spike in pricing power. However, despite the unusually robust backdrop and Old Dominion’s impressive execution, we think the share price is baking in overly optimistic midcycle performance assumptions, as investors seem to be overlooking the cyclical nature of trucking. We are not forecasting the impact of recessionary conditions, but we don’t expect current top-line growth to persist indefinitely. Year-over-year comparisons alone will become increasingly difficult through 2019. Our fair value estimate assumes a midcycle operating ratio (expenses/revenue) near 81.5% (in 2022), which compares with an adjusted 82.6% in 2017, and our 80.3% forecast for 2018. This assumes average incremental margins near 20% over our five-year forecast horizon.

Relative to the same period last year, Old Dominion’s top-line growth was driven by 12.5% higher yields (9% year to date) and an approximate 8% rise in tonnage (13% year to date). Average revenue-per-hundredweight excluding fuel surcharges increased 9% (6% year to date, versus 2.5% for the full-year 2017). Given robust leverage from tonnage and pricing gains, Old Dominion's operating ratio improved 280 basis points to 78.4% despite an uptick in average employee count to handle strong tonnage growth.