One of the real powerful forces behind this four and half year cyclical bull market has been the Dow Jones Transportation Average. After terrorizing "Dow Theorists" for nearly a year in 2012 by "refusing to confirm" new highs in the industrials, the Transports caught their second wind and ripped to new highs shortly after the new year began. A chart of the iShares Dow Jones Transportation ETF (IYT) shows this clearly. Since last January it has beaten back every attempt at a major correction:
After such a hefty advance, prudent investors might wonder if it is a time to sell their shares of IYT. How do we answer this question?
One way is to punt. Instead of selling IYT, let us look at the financials for the twenty companies in the ETF and see what this analysis tells us. If all of them are still undervalued, by all means we should hang on. If all are overvalued, it may well be time to sell your IYT holdings.
For such a small group (twenty stocks), the Transports have a surprising diversity of companies. There are airlines; truckers; shipping companies, and a few logistics firms.
I ran a subjective screen of the companies in IYT, using the following criteria:
- First, I eliminated the airline stocks. I would never own an airline stock individually: they have a long tradition of providing poor returns for their shareholders. A glimpse at a few ten year charts for component airlines like Delta (DAL), Jetblue (JBLU), Southwest (LUV) and United Continental Holdings (UAL) shows a lot of volatility and pitiful gains. The exact opposite of what investors should be looking for. Furthermore they are oil price sensitive: a more efficient way to trade this is an oil ETF. And yes, they are becoming more efficient with newer engines, but Boeing (BA) is a more efficient way to trade that issue.
- Second, I looked for companies that have shown (nearly) uninterrupted earnings growth since the recession ended in 2009. Sure maybe a soft quarter here and there; but solid growth. If the issue was a bit in doubt I turned to the company's ten year record, and insisted if growth was negative during the recession, it recover swiftly afterward and share net go on to new highs.
- finally, I wanted the company's trailing PE ratio to be near the bottom of its ten year range.
Yes, these screen criteria are more subjective than a pure computer screen would be, but this leaves room for investor analysis and judgment, which never should be off the table when making an investment.
Only one company convincingly jumped thru all the hoops: C.H. Robinson Worldwide, Inc. (CHRW).
If only one of the companies in IYT appear to be undervalued, it might give you pause about how brightly the ETF will shine in the very near future.
On the other hand, our economy shows more strength by the day. Oil prices remain stuck in a five year range. Natural gas prices are testing new lows: successful fracking techniques recently announced by EQT Corporation (EQT) in Seeking Alpha (10/17/2013 @ 2:29 PM on Market Currents) could cut over $1.5 billion from the costs of drilling for gas, as well as assuage "environmentalist" concerns about fracking. Fuel is a major cost for transportation companies. So maybe IYT can catch a third breath?
On the other hand, instead of buying IYT, why not buy its strongest component? This is the first of several articles I will write which suggests this strategy for Seeking Alpha investors: buying the strong components of popular ETFs.
A look at CHRW, then. While the company does some shipping, including fresh produce to wholesalers and restaurants, their real niche is logistics. If you do not like math, do not study logistics: it is the science of analyzing the least cost alternative for the shipment of goods. CHRW does it well: according to Etrade data, return on Assets, Equity, and Invested Capital, at 23%, 42% and 43% respectively, are at the very top in the industry. United Parcel Service (UPS) for example posts a trio of numbers only in the low teens or single digits. The same for FedEx (FDX). With soaring international trade as Asia regains its footing and even stodgy Europe joins the party, CHRW should continue to post record results. Yet valuations are compelling: PE is at a decade low.
Price/sales and price/book value ratios are also at five year lows.
The dividend yield of 2.3% is not too shabby either. Dividends have more than doubled in the last few years.
So with shares on the bargain counter, are there some roaches in the cabinet below? Some. But most analysts feel the problems are short term and the company will grow out of them. Yahoo finance reported on August 6th the acquisition of Apreo and Phoenix were part of the reason for a 30% leap in the company's headcount and 16% increase in overall personnel expenses. Yahoo has shaved a few pennies from EPS estimates for this year and next compared to a quarter ago, but recent revisions have been modestly to the upside.
If we use next year's estimated EPS of $3.18 at Yahoo Finance, and assign a conservative PE multiple of 25x earnings, that gives us a price objective just shy of $80 a share. A glance at Value Line Investment Survey shows the company traditionally commands 22x cash flow multiple. We should trim that to reflect cost pressures and time to digest earlier acquisitions. At their lows during the crash the company sold for 18x cash flow. I'll split the difference since that was probably extreme, and use a 20x multiple of Value Line's $3.40 cash flow estimate for 2013. That gives us a price of $68.
Blending these two price estimates gives us a target price for CHRW of $74 a share. That is a 23% gain from current levels, for a company with remarkably little debt and a well covered dividend. If traditional multiples of cash flow and earnings are restored when the company gets back on track, that estimate will be remarkably conservative.
Earning 2.3% while you wait makes buying these shares even more attractive.