Rising Star Buy: Landstar System

This article is part of our Rising Stars Portfolios series.

If you've ever been on a road trip and tried chugging your fist to get truck drivers to honk their horns (only to immediately erupt in laughter and high fives if you earn the "toot") this investment may be for you. No, it's not a car horn maker, but it is a company responsible for keeping all those 18-wheelers on the road. Landstar System (Nasdaq: LSTR) is a trucker's best friend, providing the platform to make sure small-time truck drivers have access to cargo to keep their big rigs filled.

While the stock is up nicely since I wrote about Landstar in September, I'm still confident the shares are undervalued. Since then, fears of a double-dip recession have calmed and we now know that the decline in substitute line haul business from the loss of a key customer hasn't caused too much harm. But Landstar is still being held down by uncertainty surrounding new trucking regulations so I'm getting behind the wheel and putting 5% of the Un Portfolio's capital into gear.

Allocating 5% to Landstar	The Five Rules Checklist
Know the BIG THREE
Identify the "Un"
Margin of Safety
Father Health vs. Father Time
Diversify

Curious about the Five Rules Checklist? I won't invest without it. Get the details here.

Going shopping for cargo
Even though Landstar is a transportation company, it doesn't own any trucks. Instead, it operates an online market where its sales agents can upload information on loads of cargo that need to be delivered. Truckers looking for work can log on and find a load that suits their eye, route, and capacity.

Here's how a typical transaction goes down:

1. Agents, acting as independent contractors, find cargo and upload its information (size, weight, and destination) into Landstar's online system.
2. Truck drivers log on to the system and find a load that matches their capacity constraints and optimizes their delivery pattern.
3. The truck driver picks up the cargo and brings it to its destination.
4. Everyone (the agent, the trucker, and Landstar) gets paid.

The hard-working truck drivers command the lion's share of each transaction. After all, they've done the heavy lifting and deserve 75% of the bounty. The remaining quarter is split between the agent and Landstar (the company generally keeps about 17%).

The key to take away is that the bulk of Landstar's costs (the payments to the truck driver and the agent) are variable: If no cargo is delivered, no party gets paid. With extremely low fixed costs (insurance, system maintenance, and a few salaries), Landstar can maintain profitability even in the bottom of an economic cycle. And since it doesn't have to buy trucks it can reinvest profits at higher returns on capital than its asset-based competitors.

Data provided by Capital IQ, a division of Standard & Poor's.

The BIG THREE reasons I'm buying

1. Network effects are beautiful. Like eBay and Facebook, the value of Landstar's business grows as more and more people use its system. Truck drivers are most likely to use the system that has the most cargo to choose from, and agents are most likely to use the system where they're certain loads will get picked up. After all, no one makes money until those loads are delivered. With 1,400 agents and more than 7,800 exclusive carriers, Landstar has the largest agent network of any non-asset-based transportation company.
2. A highway of growth. Supply chains are increasing in complexity because of the globalization of trade and foreign sourcing. This trend, combined with the popularity among the independent truck drivers in the United States, has led to increased logistics outsourcing. With this tailwind, Landstar is making inroads into total supply chain management industry -- a huge market opportunity.
3. Great stewardship. Formed in 1988, Landstar is only on its second CEO, and Henry Gerkens has been there from the beginning. The board of directors has also dictated that executives need to have skin in the game, requiring the company's CEO to own at least 50,000 shares of Landstar stock, and other executives at least 15,000 shares. Additionally, the company is managed conservatively and has a very healthy balance sheet.

What's so "Un" about Landstar?
New regulation from the Department of Transportation regarding driver compliance, safety, and accountability is expected to pull some drivers off the road due to frequent safety violations. This fact compounds the widely held belief that truck drivers are a dying breed and supply is tight. As the theory goes, fewer drivers would mean a strengthened ability to renegotiate revenue splits higher.

Furthermore, Landstar's new supply chain management operations expose the company to a new breed of competition in FedEx (NYSE: FDX) and UPS (NYSE: UPS). As a result, many people expect Landstar's entry to be a bust and assign the segment zero value.

Both of these are valid concerns, but the exclusivity of the bulk of Landstar's drivers has created loyalty and a steady stream of business. Drivers aren't likely to make road kill of the hen that lays the golden egg. And I believe Landstar's core truck brokerage business is undervalued, so any upside that comes from the complete supply chain management business is pure upside.

That's a buy
Even haters admit that Landstar's core business has an impressive economic moat. It delivers incredible value to both its agents and its drivers, and its network, built up over decades, would be difficult to replicate. It's asset-light, earns high returns on capital, has a large market in which to grow, and will make a good diversifier for the Un Portfolio.

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