LSTR: A Paired Long/Short Trade Idea Between Landstar and CH Robinson
The following is my RealMoney article from December 4, 2007.
A Tale of Two Truckers
The valuation discrepancy between Landstar (LSTR - Annual Report) and CH Robinson (CHRW - Annual Report) may present a paired-trade opportunity to be long Landstar and short CH Robinson.
A couple of weeks ago I predicted Landstar’s stock would shine again, and the first evidence of that was provided with the company’s positive mid-quarter update.
The shares were up more than 5% after the call, but it will be a while before I am ready to sell. Even after yesterday’s rally, the shares are yielding 7.1% free cash flow to enterprise value. With the five-year Treasury at 3.4%, that still amounts to more than a 100% premium, and Landstar should still provide growth.
In fact, I would be willing to own Landstar up to a parity yield with Treasuries, because I believe the growth alone is sufficient premium for the risk. On that basis, and with today’s Treasury yield and trailing Landstar FCF, I get an implied value of nearly $90 per share.
Am I Being Overly Optimistic?
That may at first blush sound like an overly optimistic forecast for a stock trading at $42. But a glance at the company’s most similar peer, C.H. Robinson, suggests it may be warranted. CHRW is trading at a free cash flow yield of just 3.1%, which would allow for even more upside than my own prognostication.
To be sure, CH Robinson is a great company, and in 2007 is showing much higher growth - an estimated 20% compared to a flat year for Landstar. But as I mentioned in my original piece, Landstar provides disaster-relief services for FEMA, and the milder hurricane season in 2006 led to lower revenue in early 2007 than was experienced after Katrina and Rita for 2005/2006.
According to Landstar’s latest 10Q, revenue would have been up 5% excluding FEMA business in both years. And for next year, analysts are predicting 15% growth at CHRW and 13.3% at LSTR - pretty close to parity if you ask me.
Are the Companies Really Peers?
The next fair question to ask is whether the companies are truly peers, or if the valuation discrepancy is otherwise justified. CH Robinson is much larger, with $7 billion in trailing-year revenues compared to $2.5 billion for Landstar. Landstar’s $185 million in operating income is also a fraction of the $497 million CH Robinson earned.
But size alone does not justify a huge valuation premium. And judging from the way the companies describe themselves, they sure do seem like peers.
In its 10Q, CH Robinson says “we are a non-asset based transportation provider, meaning we do not own the transportation equipment that is used to transport our customer’s freight.”
By comparison, “Landstar’s business strategy is to be a non-asset based provider of transportation capacity and logistics services delivering safe, specialized transportation services globally, utilizing a network of independent commission sales agents, third party capacity providers and employees,” according to it’s 10Q.
Looking at the ratios, the companies still seem like peers and if anything Landstar might deserve the higher multiples:
| Landstar | CH Robinson | |
| Operating margin | 7.5% | 7.0% |
| Net margin | 4.4% | 4.4% |
| Return on assets | 17.6% | 18.1% |
| Return on equity | 49.5% | 32.0% |
| Beta | 1.07 | 1.27 |
Even the stock chart suggests the companies are peers, as they have tracked each other fairly closely for the last five years.
Am I Using the Right Valuation Measure?
The only remaining concern is whether my choice of free cash flow yield is picking and choosing a valuation method that fits my thesis. So, I look at several other possible valuations.
Based solely on sales or operating margins, Landstar is about 35% the size of CH Robinson. If it had the same relative valuation it would trade at $52 per share.
CH Robinson’s forward P/E multiple is 24.6, compared to 19.3 for Landstar. At 24.6x estimated 2008 earnings, Landstar would be trading north of $54. Assigning CHRW’s 1.67 PEG ratio to Landstar would give it a $49 value.
CH Robinson has a lofty 16.1x EV/EBITDA ratio. If Landstar got that multiple its stock would be $60.
In fact, the only comparison by which Landstar looks more highly valued is price/book - and Landstar’s higher return on equity indicates that that multiple may also be the least valid comparison.
The more I look at it, the more I think Landstar and CH Robinson would make for a great paired trade. Both are great companies, but Landstar clearly seems like the better stock right now.
Disclosure: William Trent is long Landstar.
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