Deutsche Bank revises truckload estimates downward but still likes rails

“Ultimately we believe KNX shares will get credit for the strong management team, which has successfully digested Swift and consistently earns double-digit returns on a tangible assets,” Mehrotra wrote. “We also see a potential catalyst for KNX shares from additional acquisitions… as management confidence has likely increased following the success with Swift integration efforts.” 

Mehrotra is more bullish on KNX than the rest of the Street, calling for fourth quarter EBIT to be down 8 percent year-over-year, compared to the consensus expectation of a 15 percent drop, but still lowered Knight-Swift’s 12-month price target by $3 to $41.

Deutsche Bank likes XPO Logistics (NYSE: XPO) and rated the asset-light/less-than-truckload (LTL) roll-up a ‘Buy.’ Mehrotra, while admitting that XPO is still a “show-me story” after several disappointing quarters and running into some external headwinds, made the argument that its stock is significantly undervalued. For instance, Mehrotra explained, if you value XPO’s less-than-truckload (LTL) division at 8.5x EBITDA, a 20 percent discount to best-in-class Old Dominion, that means that XPO’s asset-light business would be valued at just two times EBITDA.

“We view this as staggeringly low given the characteristics of much of XPO’s non-LTL businesses (high organic growth, low capital intensity), even after considering the recent string of negative developments,” Mehrotra wrote.

Mehrotra also said that XPO should generate enough free cash flow to pay down debt and lower its debt/EBITDA ratio below 3x. XPO had levered up during a spree of 17 acquisitions between 2012 and 2015.

UPS (NYSE: UPS) is still being punished for elevated capital expenditures, lower margins and weaker cash flows, and, issuing a ‘Hold’ rating, Mehrotra said he’s waiting this one out, at least until the parcel carrier’s story evolves during 2019 and 2020. Ideally, UPS will start to see a return on its investments and improve margin while lowering capex back to its long-term trend.

Wall Street still likes the railroads as various cost-cutting programs and operational transformations inspired by the late Hunter Harrison continue to percolate through the industry. Mehrotra rates Union Pacific (NYSE: UNP) a ‘Buy,’ and while acknowledging that the volume data in the second quarter has been soft across the board, points out that opportunities presented by precision scheduled railroading are “volume agnostic.” Mehrotra believes that all Class I railroads will improve profit despite no top-line revenue growth in the second quarter.

“We think OR [operating ratio] guidance will be maintained for each and every rail – and possibly improved upon as the case may be for KSU [Kansas City Southern Railroad],” Mehrotra wrote. It’s still relatively early innings for the rails, which are set to generate more and more cash for years to come.

“Specifically, we forecast the group to achieve nearly 200 bps [basis points] average improvement in free cash conversion this year (to 76 percent), accelerating to 85 percent in 2020 (+850 bps) and 87 percent in 2021 (+200 bps) – equating to over 1,000 bps cumulative improvement in FCF conversion in 2021 vs. 2019,” Mehrotra wrote.

On the macroeconomic side, Mehrotra stopped short of calling for a recession – calling out record unemployment, continued strength in consumer confidence and growth, albeit slowing growth in industrial production – but said that a number of factors were a drag on demand for transportation services.

“This dynamic (weaker imports, elevated inventory levels and weaker IP/manufacturing growth) has resulted in a significant slowdown in U.S. transportation demand. We have seen evidence of this in the Cass Freight Shipment Index, ATA Truck tonnage and Class I carload data,” Mehrotra concluded.