Since I put out my cautionary piece about Landstar System Inc. (NASDAQ:LSTR), the shares are up about 1.5% against a gain of 5.5% for the S&P 500. The company has since published admittedly excellent financial results, so I thought I’d look at the company again to see if now is a good time to buy. I’ll make this determination by looking at these excellent financial statements, and by looking at the stock as a thing distinct from the actual business. Finally, as is frequently the case, I’ll comment on the options trade I recommended in my latest article.
I’ll come right to the point, dear readers. I think Landstar’s performance in 2021 was spectacular. Revenue and net income were materially higher than in either 2020 or 2019. The problem is the valuation. I think the fact that the market didn’t react positively to great news coming out of the business is a sign that the shares have gotten too optimistically priced. For that reason, I think it’s prudent to avoid the name. Further, although I did well with short puts earlier, the price is so out of whack at the moment that the premia on offer for strike prices I’d be willing to pay aren’t worth it. For that reason, I’m obliged to just sit and wait for price to fall to match value. This investing game is about avoiding losses. I think a decision to avoid this stock will help an investor avoid future losses.
Financial Snapshot
There’s no denying that the first 39 weeks of 2021 were very, very impressive at Landstar. Revenue was ~62% higher, and net income climbed by over 111% relative to the same period in 2020. In case you’re worried that 2020 was such a terrible year that comparisons to it would make the company look artificially good, fear no longer, dear readers. Relative to the same period in 2019, revenue and net income in 2021 were ~49% and 51% higher respectively. On the back of this improved performance, dividends increased by over 15% to $0.67 per share.
It’s not all animated bluebirds and sunshine over at Landstar, though, dear readers. In my view, the capital structure has deteriorated rather dramatically, with long term debt growing by ~37% relative to the same period in 2020. It is down by ~$3.4 million relative to 2019, though. For my part, I’d like to see a reduction in debt, as more debt equals greater risk in my view. Finally, stock buybacks for the first 39 weeks of 2021 fell off the cliff relative to the same periods in 2020 and 2019. The fact that the people who know the company best aren’t buying it aggressively may give the rest of us a clue.
All of my negativity aside, I’d be happy to own these shares at the right price. The fact of the matter is that the dividend is very well covered, and the company has generally treated owners well with the dividend increasing nicely over the years.
The Stock
I think there’s some evidence that the stock has “topped out.” I start to worry that this is the case when objectively good news does not manage to move the market. You may remember that the shares jumped nearly 4% in afterhours trading after Landstar gave the market some positive news about revenue and EPS. After the news was fully digested, the shares actually dropped in price and haven’t recovered since. This is actually one of the things I look for to identify a “top” in a stock. If the market reacts negatively to objectively good news, that suggests the market was expecting even better news, which is the cause of the seemingly paradoxical share price drop. This suggests (to me at least) that expectations currently baked into price are very optimistic, and that anything less than spectacular performance will cause the shares to stall.
This is one of the reasons I prefer to only ever buy stocks when they’re cheaply priced. In my experience, when stocks are cheap, good news is greeted favourably by the market.
My regular reader-victims know that I measure the cheapness (or not) of a stock in a few ways, ranging from the simple to the more complex.
On the simple side, I look at the ratio of price to some measure of economic value, like earnings, sales, book value etc. The higher the ratio, the higher the risk in my view. When I last wrote about this business, I balked at the price to free cash of just under 50 times. The valuation isn’t as egregious on that basis per the following, but it remains well above the historical norm for this business.
Shares are also richly priced on a price to book basis, per the following:
As my regulars know, I also like to try to understand what the market is “assuming” about long term (i.e. perpetual) growth at a given business. In order to do this, I turn to the work of Professor Stephen Penman and his book “Accounting for Value.” In this work, Penman walks investors through how they can isolate the “g” (growth) variable in a standard finance formula to work out what must be assumed about growth. Applying this approach to Landstar suggests the market is forecasting a growth rate of ~5.5%, which I consider fairly optimistic here. Given the above, I can’t recommend buying shares at current prices.
Options Update
The options I recommended in my previous article are currently bid at $0, which is understandable given how deep out of the money they are. This is yet another example of how powerful short put options are. I’m not going to take any action on these, as I expect they’ll expire worthless. If they don’t, I’m comfortable buying at the strike price. Note that this brings my income from short put options to $4,750 on this name. Normally I like to repeat success, but that’s unfortunately impossible in this circumstance. The premia on offer for reasonable strike prices is too thin to make the exercise worth it. For that reason, I’m obliged to sit on the sidelines and wait for prices to fall, or for the business to improve very dramatically.
Conclusion
I think Landstar is a fine company in many ways, and it’s had great success in 2021. The problem is that the market seems relatively indifferent to that. I also think the current price more than reflects that success, so there’s little to compel investors to buy at current levels in my view. I think there’s a strong negative relationship between price paid and subsequent returns, and I think investors who go long at current levels will regret the decision. This is why I’m recommending continuing to avoid these shares. I think “price” and “value” can remain unmoored for some time, but they’ll eventually meet. I think it makes sense to wait until price falls to match value.
Read More: Landstar System Stock: Valuation Is Stretched (NASDAQ:LSTR)