Transports Give Investors A Bumpy Ride

10/1/2012


When FedEx ($85; FDX) talks, the market listens.

The shipping bellwether lowered its profit outlook Sept. 18, blaming persistent economic weakness and high fuel prices. People pay attention to FedEx's news because the factors that affect the company tend to have a long reach.

Volumes for airfreight, which reach every corner of the economy, have been light this year, and we see little evidence of a near-term reversal. U.S. industrial production slipped 1.2% in August, the biggest decline since March 2009.

"Exports around the world have contracted," said FedEx CEO Fred Smith as his company cut guidance for the November quarter and the fiscal year ending May 2013. "And the policy choices in Europe and the United States and China are having an effect on global trade."  

Rising costs for fuel and other goods are causing many companies to rethink strategies. In the case of FedEx, clients striving to maintain profit margins have turned to cheaper shipping options, particularly trucks and oceangoing vessels. Softer economic demand has reduced urgency within the supply chain, leaving clients with less incentive to rush shipments through the air.

A warning from railroad Norfolk Southern ($65; NSC) on Sept. 19 demonstrates that the issues facing transports extend beyond airfreight. Norfolk reported lower shipments of coal and merchandise less than a week after trucker Werner Enterprises ($21; WERN) cited high costs as it lowered profit expectations for the September quarter.

AIRLINE PROFITS TAKE OFF, MARINE IS SINKING
Based on estimated earnings per share, the median airline stock in our Quadrix universe is projected to outgrow other transportation industries in the current year, next year, and over the next five years. Responding to recent profit warnings, many stocks' estimates have declined. Further declines are possible, and the growth rates depicted below may still be too optimistic. The PEG ratio divides the P/E based on the current-year profit estimate by the long-term profit-growth rate to measure valuation relative to growth potential.
---- Est. EPS Growth ----
Curr.
Fiscal
Year
(%)
Next
Fiscal
Year
(%)
Next
5 Yrs.
(%)
Trailing
P/E Ratio
Curr.
Year
Next
Year
PEG
Ratio
Airfreight & Logistics
0
17
13
17
16
13
1.2
Airlines
32
29
19
10
10
8
0.4
Marine
(2)
0
11
10
12
13
1.3
Railroads
12
14
16
22
18
15
1.2
Trucking
20
14
15
14
13
11
0.8
Median transport. stock
14
14
13
14
13
11
1.0

Warnings aside, Quadrix identifies a few pockets of fundamental strength in the transportation group. Railroads, airlines, and truckers earn above-average Overall scores. Looking ahead, those three industries still appear positioned for at least modest profit growth over the next five years, as shown in the table above.

In the following paragraphs, we look at the five key transportation industry groups.

Airlines

Airlines look cheap, averaging Quadrix Value scores of 82. Airlines operate in a fragmented industry, protected by high barriers to entry but fraught with highly competitive pricing. After reducing capacity in the last two years, U.S. airlines can charge higher fares to help cover soaring fuel costs. In August, traffic rose at the largest airlines, and most of these airlines have reported higher traffic year-to-date. We cover only one airline, Southwest Airlines ($9; LUV), a Long-Term Buy.

Southwest Airlines reported a 0.1% increase in August traffic but saw "some softness" in prices. Nevertheless, Southwest on Sept. 17 pushed through its fifth round of fare hikes for the year, covering roughly 10% of flights, and soon other U.S. airlines followed suit. Southwest raised its fares eight times last year. The company has delivered 10 straight quarters of double-digit sales growth, a streak that will likely end in the September quarter. Still, the stock earns a Value score of 93 and trades at just 15 times trailing earnings, 44% below its three-year average.

Railroads

The S&P 1500 Railroad Industry Index has dipped 7% over the last week. But even after that decline, the median railroad in our Quadrix universe is up 15% so far this year, topping the return of any other transportation industry. As a group, railroads enjoy favorable long-term growth records and are still expected to grow profits at double-digit rates this year and next year. However, profit estimates are declining in the wake of Norfolk Southern's warning.

Low prices for natural gas have cut into demand for coal, which accounts for more than 40% of carloads at major U.S. railroads. Coal volume nationwide is down 9% for the year. In response, railroads have set their sights on oil. Volumes have jumped more than 40% this year, but oil still accounts for less than 4% of total U.S. carloads. Prices for U.S. oil still lag those of oil produced overseas, driving demand from domestic refineries.

We cover four railroads: Canadian National Railway ($89; CNI), CSX ($21; CSX), Norfolk Southern ($65; NSC), and Union Pacific ($120; UNP). CSX is a Long-Term Buy, Union Pacific is rated A (above average), Norfolk Southern is being downgraded to B (average), and Canadian National is also rated B.

CSX shares fell on Norfolk Southern's warning; no surprise, as the railroads have a lot of overlap. Both operate east of the Mississippi River, with similar exposure to merchandise (more than half of revenue) and coal (more than 25%). The consensus still projects per-share-profit growth of 2% this year and 12% next year for CSX, yet a lot of pessimism is already baked into the shares. At 11 times trailing earnings, the stock trades 28% below the median railroad.

Trucking

Even with demand softening, trucking companies have managed to hike rates this year. But costs to purchase fuel, retain drivers, and comply with environmental regulations are on the rise, putting truckers' profit margins at risk. The consensus projects per-share-profit growth of 20% this year for the median trucker, which seems unduly high.

Looking ahead, the holiday shipping season could resemble 2011, when customers kept inventories lean to minimize markdowns. The Forecasts currently covers no trucking stocks. But our sister publication Upside, which focuses on small-caps, recommends Saia ($20; SAIA) as a Buy and AMERCO ($106; UHAL) as a Best Buy.

AMERCO is the parent company of U-Haul, well-known for its brightly colored moving trucks and storage centers. AMERCO is less known for its somewhat unusual business pairing — casualty, property, and life insurance account for about 10% of sales. The company continues to expand its fleet of self-move trucks (up 4% year-over-year in the June quarter) and rental storage space (square footage rose 11%). Scoring above 60 in all six Quadrix category scores, AMERCO earns an Overall rank of 98. Both of its sector-specific ranks exceed 96.

Airfreight & logistics

Industry leader FedEx's ($85; FDX) Sept. 18 profit warning cited weak demand, especially overseas. In July, United Parcel Service ($72; UPS) slashed its 2012 guidance, blaming customers spooked by broad weakness in global markets.

We cover only two airfreight stocks. FedEx is rated A (above average) and UPS is rated C (below average).

FedEx's new per-share-profit target of $6.20 to $6.60 for the fiscal year ending May 2013 implies earnings will be flat to down 6%; the former consensus called for 7% growth. Part of the blame goes to a deceleration in global trade, especially in China, where FedEx has invested heavily in recent years. But FedEx's weakness also reflects companies' desire to protect profit margins by selecting less-expensive shipping options. In the U.S., volumes for overnight-package deliveries fell 5%, largely because a phone customer switched to the cheaper ground service.

Marine          

Oil-tanker shipping rates have weakened in recent quarters, hurt by an influx of new ships hitting the market and economic softness in the U.S. and Europe. Analyst targets reflect those uncertainties, with the median marine stock expected to see profits decline 2% this year.

The average marine company in the S&P 1500 Index has a stock-market value of just $427 million, tiny relative to the other four transportation groups. Given the companies' small size, poor Quadrix scores, and below-market growth, we rarely find marine stocks that interest us.

HOW TRANSPORTS STACK UP
Avg.
Div.
Yield
(%)
Avg.
Stock-
Market
Value
($Mil.)
---------------------- Average Quadrix Scores ----------------------
% With
Overall
--- Above ---
Average Sector-
-- Specific Scores --
Industry (No. of Cos.
In Quadrix Universe)
Momen-
tum
Value
Quality
Fin'l
Str.
Earns.
Ests.
Perfor-
mance
Overall
80
(%)
90
(%)
12-
Factor
Sector
Reranked
Overall
Airfreight &
Logistics (16)
1.0
6,488
42
66
60
41
32
30
53
25
6
45
46
Airlines (19)
0.7
3,961
54
82
54
32
16
41
62
37
11
68
59
Marine (24)
5.6
427
35
69
32
46
41
24
41
0
0
31
40
Railroads (9)
1.4
18,571
70
43
79
63
43
64
67
22
11
49
45
Trucking (29)
0.7
1,189
64
67
52
43
41
36
60
24
17
59
53
All Transports (97)
2.1
4,068
52
68
51
43
35
36
55
21
9
50
49
Note: Quadrix and sector scores are percentile ranks, with 100 the best.     Sector scores compare industrials to other industrials

 


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