Transportation Industry Keeps on Trucking

We have all seen how the cost of fuel has eaten away at margins across the global economic spectrum, but how has it directly affecting the transportation industry? We spoke with Zacks senior equities analyst Ann Heffron, CFA recently in order to find out.

Have any companies under your coverage reported yet?

There have been two companies in my industries that have reported earnings to date—CSX Corporation (CSX) in the rail industry and Werner Enterprises, Inc. (WERN) in the trucking industry.

CSX reported strong earnings growth that was up 26% year over year, which matched the consensus. While revenues came in much higher than expected due to strong pricing trends that offset weak volume, this was offset by soaring fuel costs. CSX management affirmed previously released earnings guidance. Going forward, improved efficiency, strong yields, and share buybacks should offset weakening volumes from a slowing economy and higher fuel costs. CSX shares increased 6% following release of its earnings.

As to WERN, the company posted second quarter EPS that was down 17% year over year, but still managed to beat consensus by a significant amount. Revenues were higher than we had estimated, reflecting fuel surcharge revenues and a stabilizing rate market. Moreover, Werner experienced improving freight demand over the last five weeks of second quarter 2008 due to tightening capacity, reflecting trucking company failures that have reduced supply.

In addition, WERN implemented numerous initiatives to improve fuel efficiency, which reduced fuel consumption by nearly two million gallons compared to the second quarter of 2007. Since release of its second quarter report, WERN shares have jumped 13%.

What are you expecting from this general industry as a whole this quarter?

For the rail industry, we expect strong earnings growth driven by solid pricing and fuel surcharges. Negatively, volumes should generally be weaker due to softening economic trends, particularly in the auto, housing, and related industries. Furthermore, we expect share prices to perform in line with the market following substantial outperformance year to date. The year-to-date-median price gain for the rail industry is 15.7% compared to a 14.2% decline for the S&P 500.

As to trucking, I have been a bit surprised by the resiliency of this industry. The median year-to-date stock price gain for the trucking industry has been 21.6% relative to a 14.2% decline for the S&P 500. While industry trends are still somewhat challenging, it appears that industry fundamentals may be poised for a turnaround, in part due to reduced capacity. Supply has been reduced due to trucking failures and voluntary fleet reductions, both of which have improved freight demand for the remaining trucking companies and driven pricing and rate trends higher.

Which are your top Buy recommended stocks in this space?

We have a buy on United Parcel Service, Inc. (UPS). 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.

Any Sells, and/or general issues to be wary of?

My largest single concern is the state of the economy. While I hope that the second half will improve from the first, there are many moving pieces--the presidential election, the price of oil and its impact on the economy as a whole, and the subprime crisis and its effect upon the consumer. It’s not clear to me at this point how long these events will take to play out. However, the trucking industry is an important economic bellwether as roughly 70% of retail goods are shipped by truck.

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