Investment bank Stifel Nicolaus (NYSE: SF) thinks that publicly-traded truckload stocks are now an attractive buy, with higher earnings available at reasonable valuations. That’s just one takeaway from a raft of research released this week by Stifel and Morgan Stanley (NYSE: MS) as the banks look forward to what next year holds for transportation.
Stifel’s David Ross expects 5-7% contract rate increases in 2019, while Morgan Stanley’s Ravi Shanker, in a note published November 28, wrote, “our straight-line forecast projects 2018 trending below 2017 and 2014 and consistent with LT average levels for the rest of the year, with 2019 trending below 2018.”
In general, Morgan Stanley’s data shows trucking supply (capacity) growing faster than demand (freight), a dynamic that Shanker believes will put downward pressure on rates, while Ross thinks that capacity added in 2018 was necessary to make up for the productivity lost to the ELD mandate. Ultimately we’d like to see more visibility into productivity and hours-of-service utilization baked into capacity estimates; national supply trends are becoming less relevant as small and midsize fleets shift to regional networks to build lane density and get drivers home more often.
We should point out that while Stifel’s analysis forecasts sustained high EPS for trucking companies over the next two years, Ross recognizes that rising interest rates will tend to compress P/E multiples. In a note issued yesterday, Stifel lowered target prices on the majority of the trucking and 3PL stocks it covers.
“We made changes (mostly minor, some major) to our target valuation multiples, taking many lower to reflect where we are in the cycle and the likelihood that multiple compression continues, as interest rates rise,” Ross wrote on November 29. “Our EPS estimates remain largely unchanged, however, as we expect modest economic growth to continue into 2019 and, depending on the sector, further margin expansion due to pricing power.”
A few carriers escaped unscathed: Schneider National (NYSE: SNDR) maintained its target price at $28, a 15.5x multiple of estimated 2019 EPS, Knight-Swift (NYSE: KNX) held at $43, a 17x multiple, and Heartland Express (NASDAQ: HTLD) stayed put at $19, a 20x multiple. Notably, Stifel upgraded Ryder (NYSE: R) based on the late cycle equipment market tightness, which should be a tailwind for the rental business.
“Ryder is a beneficiary of a tight trucking market and business outsourcing trends, as equipment costs have increased significantly and maintenance of truck engines has become more complex,” Ross wrote.
Morgan Stanley’s truckload sentiment surveys reveal an industry perhaps more cautious than the mid to high single digit contract increases Stifel is calling for. Only 36% of survey respondents said they expected higher rates in the three months going forward, while 48% said rates would be unchanged.
DAT truckload spot and contract rate data charted by Morgan Stanley shows that of the three major equipment types—-dry van, flatbed, and reefer—only reefer contract rates are still hovering around their highs. Morgan Stanley says that dry van contract rates have already peaked, while spot prices have fallen about 10%, from $2/mile to $1.80/mile. Flatbed spot rates have also fallen back to earth, dropping to about $2/mile from as much as $2.40/mile, but note that these prices are roughly in line with the late 2017 peak.
There are really three interlocking questions when it comes to the performance of the transportation sector in 2019: the macroeconomic backdrop, the profitability of trucking companies in that environment, and then investors’ appetite for exposure to that kind of risk. Our view—expressed by FreightWaves chief economist Ibrahiim Bayaan in a webinar earlier this week—is that economic growth in 2019 will slow to ‘average’ levels around 2.5% and that driver-related capacity constraints are structural, not cyclical. Investor sentiment toward trucking stocks is a different kettle of fish. One factor will be the extent to which capital flows into traditional safe havens like Treasuries, the Japanese yen, and gold and away from U.S. equities; within equities, Wall Street may still feel that transports are riskier than staples and utilities. Ultimately, overall economic growth and investor confidence will dictate how willing investors are to take on equity in relatively low margin transportation companies exposed to the goods economy and trade policy risks.