During our third quarter portfolio update, we profiled portfolio holding, Landstar System (LSTR). Below is a replay of our live commentary on the company from our quarterly portfolio update webinar and an excerpt from our QUARTERLY LETTER.

Landstar

The global supply chain has been in the news a lot in the past eighteen months. In 2020, the threat of COVID and related lockdowns shuttered “non-essential” production. While most logistics companies were considered “essential,” they naturally scaled back as well. Layoffs or furloughs were common. Some cargo ships, planes, and trucks were temporarily taken off-line as the world sorted itself out.

 

And then just like that, the world economy came roaring back – and faster than expected. The American consumer in particular started spending and the global supply chain was not fully prepared for it. Dozens of cargo ships are currently stuck offshore waiting to unload at the port of Los Angeles, warehouses are full, trucks are hard to come by, and freight rates have surged higher due to the supply and demand imbalance. In a recent Financial Times article, the CEO of APM Terminals (a division of Maersk) said, “We need lower [consumer demand] growth to give the supply chain time to catch up, or differently spread out growth.”

Despite rising freight prices, new long-haul or “truckload” drivers have been slow to get in on the action. In August, one fleet owner was so in need of drivers it offered up to $20,000 as sign-on bonuses for eligible drivers. In a perfectly rational market without barriers to entry or exit, you’d expect drivers to jump on these large signing bonuses on top of more attractive base pay.

So, what’s going on? Put simply, there aren’t enough young people coming up the ranks to offset veteran driver retirements. The average age of an American truck driver is between 46 and 50 years old and early retirements are common. Veterans understand well that it’s a cyclical business and the end of upcycles often spurs them to exit the industry. In 2019, the American Trucking Association estimated the industry was short about 60,000 drivers and unless more young people entered the industry, the under-supply could swell as high as 160,000 drivers by 2028. And that was before Covid hit. Since then, industry employment has fallen even further.

The broader North American logistics industry is massive, totaling $1.4 trillion in revenue, according to SJ Consulting. For-hire truckload driving accounts for about a quarter of that total, so it’s a critical artery in the supply chain, but it’s also highly fragmented. In 2019, Knight-Swift held a 1.2% market share, which was the largest in the industry. Moreover, 80% of the fleets have between 1-3 tractors, meaning much of the industry is run by small businesses.

Running a small business on wheels is hard, particularly because it includes a lot of paperwork, regulations, and a difficult lifestyle. Truckload drivers are often away from home for days or weeks at a time. These factors also contribute to the lack of new driver supply in the industry. Truckload driver turnover routinely hovers around 100% compared with less-than-truckload drivers (who tend to be home every night) at 10-15%.

The pay drivers receive for hauling a load is revenue rather than profit and the driver must cover fuel, maintenance, truck and trailer payments, and remit other permits and tolls before he or she pockets any for themselves. Industry media site, Freightwaves, estimates that it costs about $118,000 per year to operate a truck before salary and benefits for a truck driving 120,000 miles a year.

With that industry backdrop in mind, we believe Landstar is well positioned to help drivers maximize their take home pay and keep their trailers full as they crisscross the country. We’ve owned Landstar for over a decade in the strategy and we continue to be impressed by the company’s advantages and its operational execution.

Landstar is a platform that connects shippers with agents and carriers to ensure quality cargo delivery. While Landstar also helps shippers move goods via ocean and rail, 90% of its revenue comes from connecting shippers with truckload drivers. We believe Landstar’s moat is rooted in network effects. The more agents and drivers join the network, the more effectively the platform can serve the needs of shippers looking to move goods. The more loads that flow through the network, the more eagerly agents and drivers want to join the network.

Landstar’s agents are independent, and their revenue is commission driven, so they are incentivized to build relationships with shippers and seek out higher priced loads, which tend to be more difficult loads. In 2020, Landstar had 508 agents who generated over $1 million in revenue. Some of these agencies are staffed by multiple people, but it shows that being part of the Landstar network can be lucrative for talented agents.

When a Landstar agent gets a job request from a shipper, he or she looks first for available Landstar Business Capacity Owner trucks (more on that in a moment) and if none are available, will look for available “approved” brokerage trucks.

BCOs are also independent drivers who are not employed by Landstar but have committed to hauling only Landstar loads. They own their own tractors and may or may not also own their trailers. At the end of June, there were 11,557 trucks committed to the BCO network. Depending on the type of haul, Landstar pays BCO drivers between 65-75% of the load price. This is considerably less than the 80-85% that non-BCO drivers receive in the Landstar network, but there are two key factors to consider here.

First, BCO drivers eat first. In the event that the industry cools, being part of the BCO network keeps your trailer fuller than if you were a free agent. Second, Landstar provides BCO drivers with additional benefits like quicker payment and discounts on fuel, tires, and equipment, which together account for about half of a truck’s expenses. By helping drivers reduce back-office complexity, BCO drivers can focus their attention on driving. BCO driver turnover is around 25%, most of which come from retirements and much of which represents new drivers who don’t make it through their first year, versus the industry average around 100%, which speaks highly of the program’s value.

In recent years, we’ve monitored potential threats to Landstar’s model, including digital brokerages like Uber Freight and Convoy, which eliminate the agent and directly connect the shipper with the driver. One of the reasons Uber successfully disrupted the taxi industry is that it unlocked dormant supply of cars and drivers. It’s a different story in the trucking industry where there isn’t dormant supply. Instead, Uber and Convoy entice drivers by paying them nearly the full load price. Not only does Landstar have similar mobile technology for its drivers, but because its loads tend to be non-standard (oversized loads, etc.), its customers often prefer to have a human agent to call to oversee a complicated shipment.

We view higher load rates to be sustainable. While we recognize that the industry is inherently cyclical, we also believe that drivers have been underpaid for some time and what we’re seeing is a “catch up” to better match driver income needs and higher costs related to driving a truck. Load prices will continue to fluctuate in the coming years, but we believe the floor has been reset higher. Based on consensus analyst estimates, we do not think the market fully appreciates this shift and we believe Landstar will continue to capitalize on the improved environment.

 

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For more information about positions owned by Ensemble Capital on behalf of clients as well as additional disclosure information related to this post, please CLICK HERE.

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