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Picks to Keep Truckin'

Pat Dorsey, CFA

Pat Dorsey: Hi, I'm Pat Dorsey, Director of Equity Research at Morningstar. As you know, if you followed Morningstar's Equity Research, we are big fans of companies with economic moats or structural competitive advantage, and we always maintained that some industries, frankly, are just better than others. It's just easier to make money as an asset manager or a data processor than it is running an airline or an auto parts company.

However, it's sometimes a mistake to think that industries that have poor economics don't have good investments. They may have very good operators within them or they may have companies connected to those industries that don't share the same core economic characteristics.

To wit: trucks! So I want to talk today a little bit about trucking companies, one of which is a wonderful business that's fairly valued, one that's a little undervalued, and one that looks like a screaming buy right now.

So the first is Heartland Express and this is a classic trucking company that owns trucks and drives them and hauls cargo for people--just what you think of when you think of a truck company. Unlike most trucking companies, however, this one is phenomenally profitable with returns on capital around 32% and operating margins of about 19%.

A trucking company with 19% operating margins is like an airline that pays a dividend. It's almost unheard of, and what is very fascinating about Heartland is that they do this in a very counterintuitive way. They pay their drivers about 30% more than most other ones. They have a very young fleet of trucks. These are both ways to increase costs, so you wouldn't think that the company with the more expensive cost structure in a commodity industry like trucking would be the most profitable. But what these things do is they reduce accidents, they reduce their insurance cost, they enable the company to provide better service to its customers, and they quite frankly just run a very lean, very tight ship.

We went and visited Heartland recently and confirmed our thesis that they simply execute on just about everything better than most of their peers. Heartland shares are fairly valued right now but certainly one to keep on your radar screen because the next time the economy takes a dip, the shares will probably sell off along with all of its cyclical companions.

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Second company I want to talk about related to the trucking industry is CH Robinson, a phenomenally profitable business that is basically a broker for truck space. They essentially have a network of folks who need to put stuff on trucks and ship it and owner operators who own trucks, and they essentially act as the middle man, the broker, in between the individual with cargo to ship and the owner of a tractor trailer that needs to put cargo in it.

Incredibly profitable business, as you can imagine, they don't need to own trucks. They are basically a network of computers and people that connect the buyers and sellers in this case. So the business has enormously high returns on invested capital. As a result, earnings multiples tend to be very, very high but very sustainable as well.

This is a business much like one I have talked about in the past called Expeditors International, an international freight-forwarding business. You are never going to get this business at 10 or 12 times earnings. And if you wait for that day, you are going to be waiting an awfully long time.

So although CH Robinson's earnings multiple is often very high, we think the growth prospects and the high returns on capital merit a pretty premium valuation. We think the shares right now are about 20% undervalued, so a good deal, not a great deal but an example of how a firm connecting to the trucking industry can have phenomenal economics and what we think is a wide economic moat.

Then, finally, turning to the company that I think is the best buy of this little trucking threesome: Rush Enterprises. The ticker is RUSHA. This is basically a truck dealer. They have a large network of dealerships mainly in the Southeast of the United States that sell Peterbilt trucks for the most part. They got their start out selling Peterbilt, which is a PACCAR brand, and they have since diversified into selling and having some Deere dealerships and selling Ford and Isuzu as well, but they mainly concentrate on what are called class-8 trucks, basically sort of the big heavy long haul trucks you see on the highway.

This again is not a super-capital-intensive business. It is reasonably profitable. It's not a phenomenal business, but it's a pretty good one. The service business tends to be much more profitable than the simple selling of trucks. What's really fascinating about this business, which we think it has a lot of potential to rebound fairly soon, is that for one, heavy-duty truck sales are at a multi-decade low.

The age of the U.S. fleet of heavy duty trucks is just getting pretty old, and that should spur some replacement sales coming up fairly soon, and of course the old age of the fleet is currently driving more sales and service for Rush Enterprises, which is a very profitable business for them. We think the company has earnings power of $1.50, $1.60 [per share] or so.

So with the shares at $11, you are paying six, seven times earnings for a business that should see some increased demand, but as the economy comes back and as owner operators and small trucking firms that basically deferred maintenance and deferred purchases over the past couple of years, kind of pick up their purchases and sales and maintenance over the next year or so.

So again, a business that's a pretty good business, not a phenomenal one but a good business and that's selling at a very, very cheap multiple. A fair value is about $18 so with the shares at 11, we think this is although not riskless, a pretty good deal. I am Pat Dorsey and thanks for watching.