Choo-Choo-Choose Railroads in Transportation

Zacks senior transportation analyst Ann Heffron, CFA has had a lot to consider, especially with trucking and air transport, based on record-high energy prices that show no signs of softening. We talked to her about where investors might find strength within companies she covers in the industry.

With oil (and thereby gasoline) prices showing no signs of receding, would it be safe to assume the best stocks to buy in transportation will be in railways instead of trucking or air freight?

Year-to-date, stock performance in 2008 has been best in railroads, with a median industry gain of 26.5%. This performance largely reflects the strong pricing characteristics of the industry. Not only have railroads been able to initiate general rate increases, but they have also benefited from fuel surcharges, designed to recover the costs of higher fuel expense. This has helped the railroads offset weak volume growth. Particularly hard hit have been the auto and housing sectors and ancillary industries, as you would expect.

Trucking and air freight have been another story altogether. The industry median price change for air freight is a loss of 1.9%, while for trucking companies the median stock price gain has been 8.2%. For the air freight industry, poor stock performance represents continued ratcheting down of growth expectations. Over the past several months, both FedEx Corporation (FDX) and United Parcel Service, Inc. (UPS) have downgraded earnings guidance due to weak volume growth from a slowing U.S. economy, lagging fuel surcharge recovery and increased fuel costs.

For trucking companies, stock price strength has been a bit surprising in view of the fact that the fundamentals still appear somewhat weak, given rising oil prices, declining volume and limited pricing power. This may reflect recovery from oversold positions. Despite a positive performance in 2008, the median trucking stock price is still down 11.0% for the last 52 weeks.

What about oil and gas tankers? Shouldn’t they be seeing a boost from higher pricing, as well?

Oil shipping stocks are a different kettle of fish altogether. Oil tanker shipping rates are a function of two primary factors: worldwide demand for oil and worldwide growth in the tanker fleet. Global oil demand in 2008 is forecast by the International Energy Agency [IEA] to be 86.8 million barrels per day (b/d), an increase of 1.2%, or 1.0 million b/d, over 2007. On the supply side, growth in the world tanker supply for 2008 is forecast to be 5-6%, following increases of 7.5% in 2007 and of 6.1% in 2006.

Currently, we are in a relatively strong point in the cycle where growing demand for oil transport has met tight tanker capacity, causing spot freight rates to remain above historical averages, which has caused the tanker stocks to perform very well year to date, with the industry median stock price up 12.2%. However, spot freight rates are extremely volatile. Companies in this industry can move from losses to profits back to losses in short periods of time, with similar volatility displayed in stock prices as well.

Did earnings season this quarter turn out as you planned, or were there some notable surprises?

On average, trucking and shipping earnings were generally below consensus, while air freight and railroad stocks were generally above consensus.

Which companies under coverage would you consider your top Buy recommendations currently, and why?

We have a Buy on United Parcel Service, Inc. Based in Atlanta and incorporated in 1907, United Parcel Service is the world's largest express carrier and package delivery company. The company also provides specialized transportation and logistics services. Superior operating efficiency, balance sheet strength and ROE justify a premium valuation to the peer group. Moreover, the board of directors increased the company’s share repurchase authority to $10 billion in January 2008 from $2 billion in October 2007, of which the company estimates that it will repurchase roughly $5 billion in 2008 and the remaining $5 billion in 2009. UPS just increased its quarterly dividend in January 2008 to $0.45 per share from $0.42 per share Therefore, we expect valuation to expand from currents levels.

Do you have any Sells you’d specifically warn investors away from?

We have a couple of Sells — on CSX Corporation (CSX) and Arkansas Best Corporation (ABFS).

Based in Jacksonville, Florida, CSX provides rail freight and intermodal transportation through its subsidiaries CSX Transportation, Inc. and CSX Intermodal, Inc. We recently cut our rating on CSX to Sell from Hold due to valuation. We believe CSX’s share price is being driven up by unfounded speculation regarding a potential recapitalization or buyout, as proposed by several hedge funds that have ownership interests in CSX. Because of this, CSX is the one of the most expensive rail stocks we cover, which is not supported by its fundamental outlook.

Arkansas Best is a diversified transportation company headquartered in Fort Smith, Arkansas. The less-than-truckload [LTL] Motor carrier services are provided throughout North America, primarily by its subsidiary ABF Freight System, Inc. (ABF). We are recently reduced our recommendation on Arkansas Best to Sell from Hold due to valuation. ABFS is now trading at a substantial premium to the industry, which is not justified by its fundamental outlook, in our view.

Ann Heffron, CFA is a senior analyst covering the transportation industry for Zacks Equity Research.

Comments

[bookvaluejohn:]

It is inaccurate to assert that Arkansas Best is selling at a premium valuation, the reason given for the sell recommendation. In fact ABFS is selling at the lowest multiples of EBIT and EBITDA in the LTL trucking group with the exception of YRCW which is at a discount because of its troubled recent history. It is currently selling for 4.7 times this year's expected EBITDA; 8.4 times EBIT and and 15 times EPS. It has no debt an a lot of cash. The only negative is that it is Teamster organized, a big long term problem it shares with YRCW and UPS.

2008 May 23 08:17 AM