[Below is an edited excerpt from my Q1 letter].
With inflation on everyone’s mind, you may be interested to know how real estate can help beat it. However, I’m going to deal with it from a somewhat different angle below.
Let’s start with one of our portfolio companies: Copart.
On Copart’s earnings call in February, Jeff Liaw, president, said the following:
“Today, there is more widespread inflation across our cost base overall... We have some structural protection in that, as you know, we own the vast majority of our land. And so that cost is -- we already own the land outright and therefore, don't face the inflationary pressures when it comes to rental expense to the extent that we otherwise might.” [Bold added]
Clear enough, I would say. And it got me thinking about companies that own their own real estate and have the same advantage.
Before I get to them, let’s stick with Copart for a minute.
Copart: “We Can’t Fail”
Buying real estate, instead of leasing, was in Copart’s DNA from the beginning. Founder (and still chairman) Willis Johnson made that decision at the start. He understood how owning the land in key spots would make Copart nearly invincible over time. In one of my favorite passages from his memoir Junk to Gold, Johnson wrote:
“Think of us [Copart salvage auctions] like the local sewer system. We’re a utility. Nothing can get rid of us - nothing. Two of the biggest businesses in the world are car manufacturers and insurance companies. If insurance companies don’t write insurance policies on cars, then they’re out of business. If manufacturers don’t make cars, then they’re out of business. They’re always gonna make cars, and they’re always gonna insure them. We’re the guy in between. As long as we’ve got the land in the right place to put the cars on, we can’t fail. We are like the septic tanks of the sewer system. You can’t have the system without us.” [Bold added].
Decades of buying land gives Copart an asset that is impossible to replicate today. With ~200 permitted yards (over 8,000 acres) close to major population centers, Copart’s real estate is a wide moat surrounding Copart’s castle. And it helps Copart generate ~25% returns on capital employed - with no net debt.
I have mentioned this advantage before on prior calls and letters. I have been thinking about it more because inflation has brought it to the fore. Then a friend of mine shared a story about Publix, which reinforces these ideas…
Publix: Long-term Thinking
Atticus Frank at Mercer Capital wrote about Publix, which is a privately owned grocery chain based in Florida. (“What Publix Supermarkets Can Teach Family Businesses.”) Started in 1930, it has been enormously successful: loyal customers, profit margins 2-3x times peers and a private market valuation of $45 billion.
What caught my eye was this:
“Part of Publix’s success is owed to its ownership of a considerable amount of real estate, including its distribution centers and manufacturing facilities…”
Unlike many peers, Publix owns its own real estate. And, like Copart, it has kept a strong balance sheet with virtually no debt. Publix has been around since 1930 and I am sure owning real estate has helped it survive. And I bet it helped boost Publix’s profit margins by saving on rent expense.
Why did Copart and Publix make these long-term decisions and not peers? I suspect some of it has to do with family ownership.
The founding Jenkins family still owns a large stake (~$9 billion) in Publix and managed the business through most of its life. The current CEO is the first who is not a member of the Jenkins family. But clearly an ownership culture exists:
“And while Publix does not share its average employee ownership, the figure is estimated at more than $150,000 in stock, adjusting for the $8.8 billion stake reportedly held by the Jenkins family. Many longtime staff members are millionaires. The company’s ownership structure is conducive to multi-generational value creation, aligning employee incentives with long-term thinking.”
It is hard to find this kind of ownership culture. Publix has it. Copart has it, too. Founder Willis Johnson and CEO Jay Adair own 11% of the company. I believe ownership is an important element to long-term success. This is borne out by various studies which show outperformance of family-owned firms, etc. And that is why I have made a key plank in our platform.
Old Dominion Freight Lines: Industry Leader
Finally, this brings us to Old Dominion Freight Lines (ODFL), a company I have admired for some time. ODFL is a leading less-than-truckload (LTL) carrier. You can think of LTL as handling freight that is above what FedEX Ground, UPS or the US Mail would carry (~150 pounds) but less than a full truckload (~20,000 pounds).
Earl and Lillian Congden started Old Dominion in 1934 as a single truck running a 94-mile route in Virginia between Richmond and Norfolk. (The company is proud of its history and published a 224-page ebook, available for free on its website). Today, Old Dominion has 251 service centers in 48 states and over 10,000 trucks.
The company went public in 1991 and the stock is up over 200x since. It is up 15x over the last ten years and 5x over the last five. What’s behind that winning record? And why should it continue?
There are many things I could say about ODFL’s superior performance. I could talk about its superior on-time deliveries or its low claims ratios. I could mention that, in 2021, ODFL won the MASTIO Quality Award for the 12th straight year, which recognizes it as the national #1 LTL carrier.
But I want to focus on the real estate angle - the theme of this post. Part of the secret sauce for ODFL is it owns the real estate on which its service centers operate, a significantly different strategy than the one pursued by its competitors.
Since 2011, ODFL has invested over $1.8 billion in real estate to expand its footprint. No one else in the industry has done this. And it has helped ODFL build a network that would be nearly impossible to replicate today. It’s even getting more difficult for ODFL itself to buy land.
Here is CEO Greg Gantt on the latest earnings call:
“[The hard part is] just being able to find the real estate that we need and being able to get it owned and get the building done. Sometimes you can find the land and [then] you've got to jump through [hoops] to get it zoned and meet all the building requirements and all those different things. But trust me, there's a lot of challenges out there from a real estate standpoint. It's not easy. As we've grown and as we require bigger and bigger facilities to meet our needs and to plan for years down the road, it's just gotten more and more difficult.”
As with Copart and Publix, ODFL’s investments have paid off, with industry-leading performance.
All that real estate creates a network density, unmatched by competitors, which facilitates efficient delivery in ODFL’s markets. All of this feeds into those superior on-time delivery rates and low claims ratios. Another key factor is that ODFL is non-union. And non-union carriers have been taking share from union carriers.
The end result is ODFL’s market share increased from 2.9% to 10.3% from 2002-2020:
I love these kinds of set-ups, where a company clearly has the best product and is winning market share and yet still has a relatively low share of the overall market (just 10%). ODFL is currently taking market share at a rate of about 1% per year.
Moreover, the company seems to get better with age. ODFL has reduced debt and improved its return on invested capital (ROIC), which now runs north of 20%:
Think of all things going in the right direction here: ODFL is winning market share with plenty of room to expand further. And it is increasing profit margins and returns on capital. Underpinning these strengths, is a physical network of distribution centers built on owned real estate.
Meanwhile, the Congden family still owns ~18% of the stock. They have created an ownership-centric culture with the lowest employee turnover rates in the industry and wide share ownership among employees.
Finally, to summarize the theme of this post: Companies that own their own real estate have a natural inflation hedge over competitors that do not. And this real estate, accumulated over decades, also makes it extremely difficult for competitors to replicate it today – if it is possible at all.
Thanks for reading.
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Published: April 4, 2022
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