Buy transports at the bottom of the freight cycle, starting with the cheapest companies that have plausible self-help stories, Goldman Sachs’ new transport equities analyst Jordan Alliger counseled in a recent note.
On July 10, Goldman Sachs (NYSE: GS) released an investor note initiating coverage of six transportation and logistics names.
UPS (NYSE: UPS), FedEx (NYSE: FDX) and J.B. Hunt (NASDAQ: JBHT) received ‘Buy’ ratings. XPO Logistics (NYSE: XPO) and C.H. Robinson (NASDAQ: CHRW) were rated ‘Neutral’ and Expeditors International (NASDAQ: EXPD) received a ‘Sell.’
Goldman’s coverage of ‘air freight and logistics’ returned as equities analyst Jordan Alliger came to the investment bank to replace transports analyst Matt Reustle, who left Goldman in March for private equity firm Raven Capital Management.
Despite short-term headwinds, Alliger has an optimistic secular view of the sector, which is crucial to supporting global trade and e-commerce growth. Incumbents have made the investments to build strong technology, which in Alliger’s view should protect them from so-called ‘digital disruptors,’ and there’s plenty of ‘self-help’ left in their stories as they embrace automation and optimize their networks.
“We do not discount the risk that these [digital disruptors] represent to the ‘incumbents,’ however even though the competitive pressures are real, sector valuations more than reﬂect the concern,” Alliger wrote.
The primary risk to the group’s earnings are “further economic deceleration/trade wars [which] could lead to additional EPS shortfalls,” Alliger wrote.
First, the ‘Buys.’ All six of the names covered in the note have underperformed the S&P 500 in 2019, which is up almost exactly 20 percent so far. Shares of J.B. Hunt and FedEx are actually negative year-to-date.
“Typically, the best time to invest in a transport stock is either when: there is the greatest potential for volume, and/or margin upside – often during a downturn, or valuation is so compelling as to offset fundamental concerns,” Alliger pointed out.
The main reason why Alliger rated FedEx a ‘Buy’ is valuation. Compared to Goldman’s estimates for FedEx’s next 12 months of earnings, FDX is trading at 10.9x, below its historical price-to-earnings ratio of about 12x, what Alliger calls “bottom of cycle value.” Significant investment in ground automation has compressed margins there, and the U.S.-China trade war, especially as it has evolved toward consumer technology and thus air cargo volumes have hurt the stock. E-commerce growth is the most significant tailwind for FedEx.
“FDX retains a 35 percent market share in the U.S. express markets (air plus ground; excluding Parcel Select), and is a leader in Asia, and now maintains a signiﬁcant European presence through TNT (acquired in May 2016),” Alliger wrote. “This positioning, plus strong global name recognition should enable FDX to take advantage of ongoing E-commerce trends, which is expected to grow at 15 percent annually through 2021 (with time deﬁnite, small package deliveries likely capturing increasingly larger share in B2C).”
Synergies from FedEx’s acquisition of TNT remain to be seen, but Alliger views them as merely delayed beyond fiscal year 2020, not lost. Alliger’s 12-month price target for FDX is $200.
UPS, in Alliger’s view, is also a buy on valuation (currently trading at 13.6x next-12-month earnings, well under its historical average of 17x). Over the past few years, UPS hiked its capital expenditures on initiatives like automating capacity – for example, its ‘smart hub’ in Atlanta – to 8 to 10 percent of sales versus about 4 percent historically. The market punished UPS for lowered free cash flow, but Alliger believes that those investments were necessary to drive profitable growth in an e-commerce environment trending toward shorter and shorter delivery times. Part of Alliger’s thesis is that the heightened capex cycle may be ending – for now – and UPS should begin reaping margin improvements on the back of those investments.
“The smart hub in Atlanta appears quite impressive, with state-of-the-art technology clearly a productivity enhancer (we believe this type of hub can process over 100,000 packages per hour compared to 35,000-50,000 packages at a conventional facility, with 30 percent fewer people),” Alliger wrote.
Alliger set UPS’ 12-month price target at $123.
For J.B. Hunt, Alliger made a gutsier, against-consensus call, rating the multimodal transportation provider a ‘Buy.’ Recall that Deutsche Bank’s Amit Mehrotra rated shares of JBHT a ‘Sell’ in a note also released July 10. First, precision scheduled railroading needs to deliver service improvements across the board, which should benefit intermodal demand (intermodal is 65 percent of JBHT revenue) versus trucks. Ultimately, Alliger’s J.B. Hunt thesis is dependent on a 2020 turnaround not only for intermodal operations but freight demand in general.
“Weak truck pricing (down ~20 percent YTD) is likely causing modal shift away from rail intermodal – further impacting volume,” Alliger wrote. “However, excluding a downturn, loose truck capacity should start to tighten in mid 2020 (recent Class 8 net truck orders were 12,157, or down 70 percent year-over-year).”
J.B. Hunt’s 12-month price target was set at $123 by Alliger.
XPO’s stock was punished by the market after a string of disappointments and lowered guidance. Still – and several analysts have pointed this out – investors do not seem to be valuing XPO’s high-margin, asset-light business correctly, which accounts for about 69 percent of revenue and about 50 percent of EBITDA. Less-than-truckload volumes are typically more insulated from downturns in industrial production and durable goods orders than truckload volumes, because shippers who can’t fill up an entire trailer can save money by moving freight on a pallet-by-pallet basis.
“Although the shares are down more than the rest of our coverage over the past year (XPO -46 percent over the past year vs. -7.7 percent for its logistics peers), we think it could take a few quarters to convince the Street that the issues which impacted results in 4Q18 are no longer an impediment to achieving EBITDA targets (e.g. C-level management departures, customer bankruptcy, loss of two-thirds of Amazon business, plus difﬁculties in European markets),” Alliger wrote.
XPO’s 12-month price target is $65, only about a 9.3 percent upside compared to the stock’s close on July 15. Goldman typically looks for a 20 percent upside before recommending that investors buy a stock.
Goldman initiated C.H. Robinson at a ‘Neutral’ rating on soft volume trends and contract pricing converging downward to spot, which would compress gross margins in Robinson’s North American Surface Transportation division.
“Despite the above concerns, for those investors concerned about the potential for GDP deceleration and tonnage declines, CH is often an effective hedge during times of economic duress, in our view,” Alliger noted. “History has shown that as a non-asset based transport provider, the company holds up very well versus asset-based peers during periods of declining economic growth.”
Alliger outlined C.H. Robinson’s expansion of service lines over the past several years. Now the third-party logistics provider (3PL) offers truckload, less-than-truckload, intermodal and global freight forwarding, and CHRW’s technology enables it to better cross-sell its products, Alliger argued. A case could be made that in addition to the normal counter-cyclical hedge of a brokerage, Robinson’s investment in Navisphere makes it a defensive name even against digital disruptors.
“A strong technology platform, and signiﬁcant planned future IT investments (about $1.0 billion over the next four to five years) could ensure CH can compete with the so-called digital “disruptors” increased market presence,” Alliger wrote. “CH’s technology platform (primarily Navisphere) already tenders 75 percent of customer shipments electronically, while about 50 percent of the carrier movements are fully automated.”
Alliger put C.H. Robinson’s 12-month price target at $95.
Goldman thinks that Expeditors International faces both short- and long-term headwinds, including near-term risk from the U.S.-China trade war (soft volumes on its most important Transpacific lane) and the increasing consolidation, through mergers and acquisitions and alliances, of the steamship lines. As container line capacity consolidates, the carriers should gain some pricing power – 2018 showed what a renewed sense of discipline among boxship operators can look like – and compress freight forwarders’ margins.
“Should additional tariffs be imposed or if the U.S.-China trade relationship deteriorates further, we think it could impact EXPD disproportionately within our coverage group,” Alliger wrote. “We expect EXPD’s net revenue growth to decelerate to the low-single-digit range at best – from up 13 percent in 2018, and EBIT as a percentage of net revenue to dip below 30 percent – a key operating efﬁciency benchmark.”
Alliger set EXPD’s 12-month price target at $70.