Transports Week In Review - Recent Downward Trend Is Seeking Increasing Demand To Offset Inflationary Pressures

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Includes: AAL, AAWW, ALK, ARCB, ARII, ATSG, CGI, CNI, CP, CVTI, DPSGY, ELD, EWC, EWW, EXPD, FCNTX, FDX, FWRD, GBX, GDP, GWR, KNX, LTL, MATX, NSA, NSC, ODFL, R, RAIL, RLGT, RRTS, SAIA, SAVE, SNDR, SPY, UNP, UPS, USAK, VFINX, VLRS, VTI, WAB, WERN, XPO, XTN, YRCW
by: James Sands

Summary

The XTN transports index is now up 1.9 percent, whereas the SPY is up 10.7 percent.

Airlines, rail operators, railcar manufacturers and lessors and logistics providers have led declines.

Container lessors and air freight and package delivery companies have been bright spots; trucking industry has remained mixed.

Demand continues to show signs of improvement; the market is looking for improving macro conditions to be reflected within company financial performance.

Source: Google Images

As we closed the week on August 4th, transports witnessed their third consecutive weekly decline, whereas broader markets were marginally positive. With many companies reporting now, weaker performers have witnessed inflationary pressures whether purchased transportation or labor related.

With improving gross domestic product [GDP] performance in the first half of the year, and improving freight demand indicators as we move into the peak shipping season, demand is poised to translate to improving financials for transports. This is what the market is looking for to offset the current inflationary headwinds weighing companies down.

I manage the Lean Long-Term Growth Portfolio (LLGP). To date, performance stood at 10.7 percent, as highlighted in green. Transports have weakened over the past few weeks. The anomaly remains the NASDAQ Transportation (^TRAN) index, now up 11 percent. Both the NASDAQ (^IXIC) and Fidelity Contrafund (FCNTX) remain strong, up 18 and 20.8 percent.

The Dow Jones (DJT), SPDR S&P 500 ETF (SPY), Vanguard 500 Index (VFINX) and Vanguard Total Stock Market ETF (VTI) were all up 10 to 12 percent. Mid- and small-cap indices continue to lag larger capitalization and broader diversified peers. Transports, for the most part, have also underperformed.

YTD 2017 SPY Vs. XTN Index Prices

For 30th week of 2017, the spread between the SPY and the SPDR S&P Transportation ETF (XTN) increased with the SPY up by 8.8 percentage points. The SPY improved by 30 basis points (bps) to 10.7 percent, while the S&P Transportation ETF declined by 40 bps to 1.9 percent for 2017.

After hitting a yearly high, transports have now witnessed three consecutive weekly declines, as volatility continues to impact broader performance. Despite this, I see the current position as positive, especially for companies with near-term catalysts. The lows set this past May could be a bottom for the year, with further upside potential remaining over the next four-plus months due to tightening capacity, among other items.

Rail Operators

Rail operator performance was mixed, with negative performers having lower results for the third consecutive week. Positive performers for the week including Norfolk Southern (NSC), Canadian National (CNI) and Genesee & Wyoming (GWR). Rail operators have been a strong contributor to the broader transports declines over the past few weeks. On a percentage point basis, Union Pacific (UNP) Norfolk Southern and Canadian Pacific (CP) have led declines.

Week thirty of 2017 witnessed increased results for most Class Is based on total traffic carried. However, the rate of improvement from the previous year declined once again, with the strongest impacts to carload traffic. The most recent monthly Class I rail traffic report can be found here.

Railcar Manufacturers & Lessors

Railcar manufacturers and lessors were mostly up for the week, with exceptions being American Railcar Industries (ARII) and Westinghouse Air Brake Technologies (WAB). FreightCar America (RAIL) surged higher this past Friday as the company beat analyst estimatses. The Greenbrier Companies (GBX) also has recovered from recent lows. During the three-week transports decline, performance has been mixed as well, with all peers being positive, the only exception being Westinghouse Air Brake Technologies.

Sentiment for railcar manufacturers remains mixed as the potential to beat estimates, when realized, is viewed positively, but the cycle bottom is still uncertain. This sets up instances where anomalies between rail operator performance come to friution. Longer term, the market is likely awaiting a sign of increasing rail capital expenditures to signal a healthier railcar manufacturing environment.

Truckload Carriers

Truckload carriers were mostly up during the week, with most companies only witnessing marginal improvement. Companies with negative performance were wide-ranging from a scale perspective, including larger peers like Ryder System (R) and Schneider National (SNDR), to Roadrunner Transportation (RRTS) and USA Truck (USAK).

Many trucking companies have witnessed a decline over the past few weeks, but some have remained positive, including Werner Enterprises (WERN), Swift Transportation (SWFT) and Knight Transportation – larger peers. For smaller peers, notable positive performers during this time have included Celadon Group (CGI) and Covenant Transportation (CVTI).

Tightening capacity over the next year or so is expected to maintain a stronger freight rate environment, serving as a catalyst for improving financial performance. This should counter current inflationary pressures of purchased transportation costs and driver-related expenses.

Less-Than-Truckload Carriers

Less-than-truckload [LTL] carriers were all down for the week, with the exception being Forward Air (FWRD). Performance over the past few weeks has been mixed. Forward Air and Old Dominion Freight Line (ODFL) have been down strongly, while Saia (SAIA) has been flat and ArcBest Corporation (ARCB) and YRC Worldwide (YRCW) have been up robustly.

Seasonal rates since late-March have accelerated as we approach the peak shipping season. Seasonal performance during this period has outperformed most truckload services with exceptions being heavy haul and specialized.

Air Freight, Package & Delivery

Air freight, package and delivery companies were up for the week, led by Atlas Air Worldwide (AAWW). Since my call on Atlas Air over Air Transport Services Group (ATSG) back in mid-May, the former stock price is up 43 percent. This compares to Air Transport’s 8 percent return during the same period. Both companies are close to fair value for the short term. This peer group has largely been positive over the past few weeks, with the exception being FedEx (FDX), due to the TNT Express issues.

Deutsche Post DHL Group (OTCPK:DPSGY) has also been having a banner year. FedEx will likely hover around the $205-$210 level until more clarity is provided related to the TNT Express impacts. United Parcel Service (UPS) witnessed solid earnings results, but appears to be close to fair value as well. Like most industries, increasing freight demand over the next few quarters could drive prices higher.

Contract Logistics, Forwarding & Brokerage

Contract logistics companies were mixed for the week, with both Radiant Logistics (RLGT) and XPO Logistics (XPO) down. Through early-August, this group has witnessed substantial volatility to the downside, with Expeditors International (EXPD) being the more recent exception with positive momentum. This peer group has witnessed strong declines for the most part, over the past few weeks.

Expeditors was expected to provide its earnings report this past Friday, looks like it will be reporting early next week. I am cautiously optimistic that the company will see solid performance based upon recent peer results, but competitive factors may have impacted margins.

Container Shipping Lines, Charter Owners & Container Lessors

For the container shipping industry, weekly performance for companies with exposure was highly mixed. Matson (MATX) and container lessors were positive, while most container charter owners and managers were down. Over the past few weeks, the same can be said, as container lessors have been up substantially.

Container lessors being up for the year is not surprising, but the extent of their run has been challenging to predict. Major global container shipping lines, including Maersk Line (OTCPK:AMKBY) and Hapag-Lloyd (OTCPK:HPGLY), have witnessed stock price appreciation of 18 and 54 percent, respectively – just no comparison to the 122 to 224 percent returns for container lessors.

Airlines

Airline stock performance for the week was mostly positive, with exceptions being Alaska Air Group (ALK), Spirit Airlines (SAVE) and Controladora Vuela Compania de Aviocion (VLRS). Airline stocks have been on the poorest performing transports industries over the past few weeks.

My focus has been on building a position in Alaska Air Group. The company has already begun to pay down its debt taken for the recent Virgin America acquisition. This has improved its shareholder equity and other fundamental measures.

Demand Trends

Key demand-based indicators that are monitored include Class I rail traffic, trucking industry tonnage, shipments, and loads, air cargo tonnage, container shipping line twenty-foot equivalent units, TEUs, North America seaport TEUs, shipping lane port calls, North America cross-border trade, and freight rates for most of these indicators.

U.S. & Canada Class I Rail Traffic – Carloads & Intermodal Units Carried

Through the thirtieth week of 2017, total traffic remained up 5.1 percent with carload traffic up 5.9 percent, down 30 bps, and intermodal traffic up 4.3 percent, up 20 bps. Week thirty performance remained solid, although it declined from the yearly average for the third consecutive week.

These numbers continue to not be far off from the total traffic originated results of 5.4 percent for the first thirty weeks of 2017 for North America rail traffic, published by the Association of American Railroads (AAR) data. Investors should remember that total traffic carried includes both originated and received carloads and intermodal units. Additionally, U.S. traffic was up 4.2 percent and Canadian traffic was up 11.5 percent, closely tracking the carried rail traffic when combined. Mexico traffic was down at -0.3 percent, as improvement has continued.

Container traffic was up 4.3 percent, up 20 bps. Through early-July, domestic intermodal pricing for both eastbound and westbound averages have improved being up 9 to 10 percent versus last year. Fuel surcharges have been a big part of improved pricing, core pricing has been up modestly.

Week thirty witnessed weekly coal carload traffic at 113,000 carloads carried. This reflected a -1.1 percent decline versus last year. Week thirty reflected the first week of the year with negative performance. Grain performance was down, at -16.4 percent versus last year. Similar to coal, weekly growth from this point forward will be choppier; this was the fourth consecutive week of negative performance.

Motor vehicles and equipment carload traffic performance was down -5.3 percent versus last year - the third consecutive drop from previous performance levels. Chemicals were up 3.8 percent, petroleum products were down at -4.9 percent and crushed stone, gravel and sand remained on a roll, up 22.8 percent.

Trucking Industry

Source: Cass Information Systems, Cass Freight Index

As of mid-July, dry van trucking industry spot rate averages increased further, being up nearly 16 percent from last year. Seasonal performance has remained strong led by flatbed, heavy haul and specialized services, which have gained momentum. LTL has remained strong while dry van has lagged, and temperature-controlled services have continued to be the most volatile.

In line with improving demand trends, tractor and trailer orders have continued to show positive momentum on a monthly basis. June U.S. trailer orders were up over 50 percent from the last year, with more than 20,000 orders. Also, as of June, North American Class-8 tractor production reached a nine-month high. Investors may be a little skittish because of the long bull run. Demand indicators suggest there is still room to run.

Air Cargo

Strong air cargo demand numbers continue to roll out. This has ranged from American Airlines Group (AAL) investing further into its European trucking network, to continued robust airport and cargo provider results. Amsterdam Schipohol aiport’s cargo traffic grew nearly 9 percent through June of 2017. Lufthansa Cargo’s traffic increased by nearly 5 percent in the second quarter with yield improvement at 10 percent.

Collectively, global air cargo traffic has increased by over 10 percent through June of this year. Total traffic grew by 11 percent in June versus last year. Strength was measured across all global regions. Similar to rail operators in North America, the midyear may have reached a peak. Still, expectations are for high single-digit growth in the coming quarter. As an indication of strong demand, FedEx joined UPS in exacting peak shipping charges to discourage excessive packaging.

Container Shipping Lines

Source: Alphaliner – Top 100 Operated Fleets

Pricing for spot market container rates have remained in a downtrend since the peak in mid-January, per the Shanghai Containerized Freight Index (SCFI). But the last week of July did display a significant uptick with the peak-shipping season approaching. For the first week of August, rates remained stable.

Year over year (YoY), the Shanghai to West Coast average spot rate was up 30 percent; to the East Coast, average spot rates were up greater than 40 percent. Asia to Europe average spot rates were mixed. The trans-Atlantic trade also remained mixed.

Last week I mentioned the International Longshore and Warehouse Union’s (ILWU) three-year contract extension through July 2022. This serves as stabilizer for trans-Pacific trade, which should lead to sustained demand in the near term.

North America Seaports

Top North America seaport container traffic accelerated during the month of June to greater than 8 percent from last year. Canadian seaports dominated June performance on the West Coast, with the Northwest Seaport Alliance [NSA] being strongly impacted. Savannah, Charleston and Virginia seaports dominated the East Coast. Gulf Coast seaports were strong across the board, with the exception being New Orleans.

Similar to the container shipping line section, the ILWU will have an impact on keeping the West Coast competitive against other North America regions. This places some pressure on the unionized labor representing the East and Gulf coasts as any sip up could shift priorities back to the West.

North America Cross-Border Trade

The iShares MSCI Mexico Capped ETF (EWW) was down by 50 bps for the week. The index continues to outperform the iShares MSCI Canada ETF (EWC). The Mexico index is now up 28.4 percent for the year versus the 6.2 percent result for the Canadian index, which was a 50-bp decline.

International trade policy has been a roller coaster during 2017. While it may seem that there has been some milder rhetoric of late, investors should continue to expect the Trump administration to potentially take firmer stances in the near term. While much of the public commentary may just be posturing, markets still will be susceptible to volatile reactions.

Summary

Overall, transports have performed in a weak fashion these past few weeks. Air freight and package delivery peers and container lessors have been bright spots. Airlines, rail operators, most railcar manufacturers and lessors, and contract logistics providers have been poor performers, leading the downward trend.

There has been some instability derived from inflationary pressures specific to certain carriers and logistics service providers. As we continue to remain in an economic expansion, which is witnessing improving freight industry demand indicators, company financials are poised to witness increasing growth, potentially offsetting current headwinds. This is what analysts and the markets are looking for, to push higher.

The initial read on a tangible catalyst to drive industries higher is the electronic logging device [ELD] federal mandate which will go into effect this December. A tightening trucking industry is set up to serve as a near-term catalyst for both the trucking and rail industries over the next couple of years. This event, depending on the magnitude, will have a ripple effect on all other freight industries, as trucking is connected to final wholesale, retail and consumer destinations.

Disclosure: I am/we are long CNI, KSU, GBX, SNDR, ODFL, FDX, DPSGY, HUBG, XPO, MATX, ALK.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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