Landstar Systems (LSTR) is a trucking logistics company that we’ve owned in various size for the last five years and which we’ve been adding to in recent months. When you are driving down the freeway, you invariably pass many big rig trucks. One fact about trucking that surprises most people is that only 10% of trucks are owned by trucking companies with the other 90% owned by individual drivers who own one or maybe a couple of rigs. So on the shipping capacity side, there is huge fragmentation and a large need for a way to centralize the process of allocating shipments to individual trucks. The shipper side is just as fragmented with even large shippers often managing their shipping at the individual warehouse or factory level. Landstar plays the role connecting shippers with truckers and their business model generates a huge amount of cash.

Trucks are the primary way that goods are moved around the United States. The one form of competition is trains, which are economically more efficient when you want to move goods more than 800 miles. But trains of course only fill the long haul portion of movement with individual trucks needed to unload goods from trains and get them to their primary destination. So while trucks (and trains!) may seem very old fashion, they are the key channel through which goods (purchased online or offline) move through the economy.

Landstar Systems doesn’t themselves own any trucks. Instead, they provide a marketplace of sorts where truckers, shippers, and agents come together to source loads and offer capacity. Landstar gets about 15% of the revenue for each load shipped via their system with the rest going to agents and truckers. Of the revenue they keep about half is pure profit with the rest going to run their business. Over time, their profit margin has been increasing as they run more and more shipments through their somewhat fixed cost infrastructure. We estimate they book as profit almost 70% of each incremental dollar of net revenue they collect, meaning that their profit margins can continue to grow for a long time.

Like any value added middleman, Landstar needs to generate value for each side of the transaction in order for their business to be sustainable. For shippers large and small, Landstar provides a single point of contact and takes on the responsibility to ensure that loads get delivered. Attempting to contact individual truckers directly would be time prohibitive for shippers and so Landstar provides value by aggregating the highly fragmented trucking industry to provide on-demand shipping capacity.

For truckers, Landstar offers access to a huge volume of loads and crucially, the potential to keep their trucks full as they are driving around the country. Being a trucker is a tough job. While it is a reasonably high paying, especially since it does not require a college degree, the higher than average pay is earned through long hours, the need to be away from home constantly and the negative health impact from sitting almost all of the time.

The key to being successful as a trucker and earning good money is to keep your truck full as much as possible. If you haul a load from California to Florida and then drive an empty truck up to New York to pick up your next load, you won’t earn nearly as much money as if you are able to pick up a new load in Florida and bring it to New York on the way to pick up your next load. Landstar offers ambitious truckers the opportunity to keep their rig fully optimized and earn good money.

Over the last year or two, Landstar has seen a slowdown in revenue growth as the price truckers are able to charge per load has declined. While Landstar truckers haul very little energy-related equipment (about 3% of revenue), the huge fall off of activity in the energy industry has brought a lot of truckers who were hauling drilling and fracking equipment into the general market. This influx of energy-related trucking supply into the general hauling market has crimped pricing and with it Landstar’s revenue. Separately, lower diesel costs have reduced the “fuel surcharges” billed to shippers. While this has reduced the headline revenue per load that truckers are receiving, these are zero margin revenues and so this portion of the decline in Landstar’s revenue is not hurting their bottom line.

On the demand side, while the overall economy has been growing, most of the growth has been in service related industries. While Landstar hauls all sorts of loads, they specialized in flatbed hauling of oversized loads that are often heavy machinery. The industrial and manufacturing portions of the US economy have seen little growth in recent years, dampening demand for trucking.

But by using a longer term time frame to think about supply and demand, the dynamics are different. The supply of truckers has been very constrained over the years with fewer and fewer young people entering the industry. We expect that over time, demand for flatbed trucking will rebound to more normal levels. Taken together, this should lead to steady growth as loads and pricing grow in line with the US economy and Landstar continues to take market share.

We also think that truckers are likely to be in a position to demand higher wages over time. This will drive up market prices for trucking and provide a high margin tailwind to Landstar’s revenue since they receive a fixed percentage of revenue per load. The chart below shows the long-term trend in trucker wages relative to private sector wages overall. While the current supply imbalance will prevent increased wages in the near term, we expect that over time trucking wages are likely to grow at a faster rate than overall wages (which appear to be on the verge of picking up).

Due to not owning trucks themselves, Landstar does not need to plow their earnings into buying trucks in order to grow. Instead, the company is a free cash flow machine. In the past three years, their free cash flow has averaged 115% of net income. The company has been savvy with their excess cash, systematically buying back shares (but doing so on an opportunistic basis) so that their share count today is 20% lower than in 2008 at the onset of the financial crisis. Along the way they’ve paid out a small, but consistently growing dividend along with a number of special dividends to opportunistically return cash to shareholders.

While Landstar isn’t the most glamorous business in our portfolio, we think that it is a high-quality company with a very lucrative business model that currently can be had relatively cheaply due to market worries about more economically sensitive stocks.

Ensemble Capital’s clients own shares of Landstar Systems (LSTR).

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