A Trucker for the Long Haul
By Jim Corridore
Standard & Poor's Focus Stock of the Week is Landstar System Inc. (LSTR ). S&P recently upgraded Landstar to 5 STARS (buy) from 4 STARS (accumulate), reflecting its belief that the company is an undervalued participant in an industry which we expect will see an increasing amount of investor interest.
Given the cyclical characteristics of the trucking industry, investors generally bid up these stocks in advance of an actual earnings and economic recovery. And that has been the case with the performance of the trucking group so far in 2001. Year to date through August 16, 2001, the S&P Trucking index had risen 12.6%, versus a 10.5% decline in the S&P 500 and a 9.6% drop in the broad-based S&P Super 1500 composite index. Landstar has outperformed the industry and the broader market during that same time period, rising 38%.
That's an impressive advance. However, we at S&P feel Landstar will continue to outperform the market and its peers over the next six to 12 months and show significant price appreciation.
OTHER PEOPLE'S RIGS.
The company operates one of the largest families of truckload carriers in North America. Truckload carriers transport large shipments, which are generally the only items on a particular truck, from origin through destination. This is distinguished from less-than-truckload carriers, which generally carry smaller shipments from several customers on the same truckload.
Landstar's operating strategy and what we believe is a major competitive advantage is to limit investment in fixed assets by using independent owner-operator drivers and commissioned sales agents. What this means is that Landstar generally does not own the trucks; it contracts with independent owner-operators to transport goods. Landstar compensates these independent contractors with 60%-70% of the revenues generated per load if they provide their own tractor, and 75%-79% per load if they provide both tractor and trailer. In addition, commissioned sales agents are compensated with 5%-8% of the gross revenue on a shipment.
While Landstar does share revenues in this manner, the benefits versus the traditional business model of owning fleets and hiring salaried workers are tremendous. Landstar is able to sharply cut its investment in equipment, which means extremely low capital expenditure requirements. Its business capacity owners (BCOs, Landstar's terminology for its independent owner operators), are responsible for expenses including fuel, which limits the company's exposure to rising and falling fuel prices. The system also allows the company to have a highly efficient operating structure, as it uses its BCOs on an as-needed basis, and does not have a fleet of trucks sitting unused during down times.
In early 2001, the company saw defections among its BCOs, reflecting the fact that they were not able to recover rising fuel costs. Some BCOs returned to traditional truckload carriers to get a steady income stream rather than the piece of the pie they receive under Landstar's operating system. This, along with a difficult operating environment in the trucking industry due to the overall economy, impacted growth for the company in the first half of 2001. However, the company said recently that it is on track to replace all its lost truck capacity by the end of 2001. This will position the company well from an expected economic recovery in 2002.
Due to the difficult trucking operating environment and the lower truck capacity issue, we expect only modest revenue growth in 2001. Given expectations of economic improvement in 2002, we forecast moderate growth in shipping demand. Adding expected improvement in the truck count due to improved capacity, we expect 5% top-line growth in 2002.
Given the company's variable-cost model and tight operating structure, we see margins widening in both 2001 and 2002. Commission payments should decline and insurance and claims expenses are likely to rise at a slower rate than revenues. Selling, general and administrative costs should decline modestly as a percentage of revenues. We at S&P see operating margins widening to 7.0% in 2001 and 7.2% in 2002 from 2000's 6.7%. Net margins should see a modest benefit from decreased interest rates. We see earnings per share of $5.52 in 2001, representing 10% growth over 2000, and $6.40 in 2002, a 16% increase.
While stocks in the trucking industry generally trade at a significant discount to the overall market, due to the cyclical nature of the industry, we expect that discount to continue to narrow over the next six to twelve months due to investor rotation into trucking stocks. This reflects expectations of a stronger operating environment and improved operating results for trucking companies as the economy improves. This should allow the trucking group as a whole to continue to outperform relative to the overall market.
Due to its competitive advantages, strong and consistent track record of earnings growth, good cash generation and lower valuation relative to its peers on a number of financial metrics, we see Landstar outperforming the trucking group in the intermediate term.
AT A DISCOUNT.
The company is currently trading at a price-to-earnings ratio of 14 times S&P's 2001 EPS target of $5.52 and 12 times our 2002 EPS forecast of $6.40, versus an average p-e of 17 times 2001 and 14 times 2002 for the universe of trucking companies we follow. On a p-e-to-growth rate basis, using an expected 5-year EPS growth rate for Landstar of 16% (more conservative than the street's 18% consensus growth forecast) the stock is trading at a p-e/growth of 0.77 versus the group's 1.2.
One of the largest benefits to the company's operating model is its low capital expenditure requirements due to the fact that it does not need to invest in a large fleet of trucks, which helps the company generate excellent cash from operations. The company has grown cash flow every year since 1996, and over the past 8 years cash flow has grown at a compounded annual growth rate of 31%.
Our cash flow model, using highly conservative cash flow growth estimates (8% growth declining to 5% growth over 10 years and 2% in perpetuity, assuming one negative year every three to reflect the cyclicality in the industry) shows the stock trading at a sharp discount to the future value of its cash flows. This method gives us a fair value for the stock of about $109 a share.
We have set a price target of $96 for the stock, which would value the company at 17 times our 2001 EPS estimate. This would give the company a p-e/growth of 1.06 using our conservative 16% long-term EPS growth rate, still below the peer group, and applies the group average p-e for 2001 to the company. At this price target the shares would still be trading at a discount to our cash flow model and the overall market. However, in light of the cyclical nature of the industry and the fact that these stocks historically usually trade at a sharp discount to the market on a p-e, p-e/growth and cash flow basis, we think a continued discount is appropriate.
S&P's price target represents potential price appreciation of 25% over the next six to 12 months, which would, in our belief, sharply outpace the overall market over that same period. Given a consistent track record of growing cash, EPS and revenues, expectations of future economic improvement, and the history of investors rotating into trucking stocks in advance of actual economic improvement, we at S&P are extremely bullish on the future prospects for the company and the stock.
Additional positives in valuing the stock include the fact that Landstar has the highest sales per share in our trucking universe, and that it has been favorably disposed to using its cash to buy back stock in the past. The company repurchased 116,000 shares of its stock in the second quarter of 2001, and should continue to make share repurchases in the future, aiding EPS comparisons.
Please note: Focus Stock of the Week will not be published on Monday, Sept. 3. It will return on Monday, Sept. 10.
Corridore is an equity analyst covering stocks of transportation companies for Standard & Poor's