Description

Landstar is a non-asset based transportation company based in Jacksonville, Florida. The company is unique given that it operates by coordinating shipments between independent business capacity owners (BCO) and independent sales agents. As a result, the bulk of costs for this business vary with revenues (unlike traditional trucking companies that have large fixed-cost components). The rest of my writeup will hit the highlights of the company's business and financial model in the interest of keeping it brief. I will be happy to discuss the business in more detail within the comments section.

Business:

Landstar generated approximately $1.4 billion (estimated) in revenues during 2001. They achieved this size (4th largest U.S. trucking company) by utilizing a network of 7,500 BCO's (truck drivers that own their equipment) and 1,000 sales agents. BCO's use Landstar's information systems to locate shipments that need delivery along with "back haul" routes so their trucks will stay loaded on both legs of the trip at premium rates. The sales agents maintain relationships with shippers across the U.S. and post business on the Landstar system. BCO's typically earn 74-75% of the revenue generated by hauling freight. Sales agents earn 6-9% (avg. 8%) commission for the business they generate. Though neither the BCO's nor the sales agents work exclusively for Landstar, both generate the vast majority of their business from Landstar.

The Landstar model has several key competitive advantages. The most important advantage is the size and scope of the business. Given Landstar's lead, it would be very difficult to build a Landstar copy from scratch (closest competitor using similar business model does $175 million in revenues). Copying the Landstar system would require simultaneously gaining scale in both the BCO area and among sales agents. For without sales agents generating business, it's difficult to attract BCO's. Without BCO's ready to accept business, it's very difficult for sales agents to sell transportation products. There is value created as the network of BCO's and sales agents grows.

Landstar also operates an offshore insurance subsidiary to cover liabilities and damages caused by Landstar BCO's. A hallmark of Landstar's business is their emphasis on safety. BCO's are required to purchase much of their own insurance, but Landstar buys a primary coverage policy to cover liabilities and damages. They use their insurance subsidiary to retain some of the risk (up to $5 million for a single incident). Given the size of their operation, they are able to make accurate actuarial assumptions regarding the accident rate of their BCO's. Providing their own insurance insulates LSTR from price spikes in insurance pricing that result from events unrelated to the company.

Financial Model:

Landstar's cost structure is highly variable. The following table shows the basic income statement model during the past 3 years:

2000 1999 1998
Payments to BCO's 73.8% 73.6% 74.0%
Agent Commissions 8.0 8.0 7.9
G&A 9.2 9.3 9.5
Insurance 2.3 2.5 3.1
D&A 0.9 0.8 0.8

Operating Income 5.9% 5.7% 4.7%

The company has clearly benefited from economies of scale enabling operating margins to improve significantly over the past 3 years. As Landstar grows revenues, there is more room for operating margin improvement as they spread information system costs, and other G&A, over a larger revenue base.

Perhaps even more impressive are returns on equity and returns on capital. The following table shows the details:

ROE = net income/common equity
ROIC = NOPAT (op. inc. taxed at 35%)/common equity + debt + other LT liabilities

ROIC ROE
1998 20.4% 30.8%
1999 23.3% 43.0%
2000 22.3% 44.8%

Management:

Insiders own just under 6% of the company. Perhaps more importantly, the senior management team is very experienced and very involved in the transportation industry. Most senior managers have been with Landstar since the 1980's. Lastly, they've shown a willingness to pursue financial strategies that create shareholder value (buying back stock).

Share Buybacks:

During the past 4 years, Landstar has used most of their free cash flow to purchase shares. Since 1997, Landstar has purchased 31% of their outstanding shares (diluted sharecount fell from 12.58 million shares to 8.63 million shares). Given the incredibly small capital requirements of the business, LSTR can continue to use cash to buy shares or reduce their small debt load. These actions will have a dramatic positive effect on per-share intrinsic value.

Valuation:

In my opinion, LSTR is an excellent investment for those investors looking for quality businesses at reasonable prices. Also, LSTR has enough daily volume so liquidity issues won't be a concern for most investors.

At $76, LSTR has a total enterprise value of $720 million ($655 market cap + $65 net debt). LTM EBIT and EBITDA was $84 million and $98 million respectively. EBIT and EBITDA multiples are 8.6x and 7.3x respectively. These are very reasonable multiples for a company that can generate significant free cash and is using that cash to buy company shares. Though I never use relative valuation to evaluate a company, LSTR's best comparable -- CH Robinson -- trades at 16.0x EBITDA.

LSTR is best suited for investors with a 3-5 year time horizon. Over that period, it's highly probable that the company will dramatically increase per-share intrinsic value. In the meantime, there is little risk of permanent capital loss.

Catalyst

1. Share buybacks
2. Valuation