Truckload stocks upgraded as fundamentals ‘bottom’

Alliger pointed to a “bottoming of the industrial weakness” as the Institute for Supply Management’s (ISM) Purchasing Managers Index (PMI), a survey of manufacturing supply executives, has bumped off of recent lows. While still in contraction territory at 48.1, the index has moved off of what could be this cycle’s low of 47.8. He also referenced a recent sequential movement higher in an internal manufacturing index as reasoning for his assertion.

Further, Alliger believes that truck capacity could be normalizing as new truck builds are forecast to decline “sharply” in 2020. “Much of the surplus should burn off as we exit 2020,” Alliger said. More specifically, he believes a reversal in the excess capacity dynamic is likely in the third quarter of 2020.

He also suggests this is a good time to invest in the cycle as “[TL] fundamentals are extremely challenging,” with volumes, pricing and future profit declines remaining obstacles, and noted that an inflection point may not be realized for “several quarters.”

This longer-term view of a turnaround in the TL environment was also reflected in Alliger’s earnings estimates, which he noted were 8-10% below current consensus estimates for 2020 with his 2021 earnings-per-share forecasts approximately 8% above consensus. He went on to say that while the TL stocks have rallied 26% in 2019, they are only 6% higher on a last-12-months basis, which included selloff at the end of 2018 as pricing and demand eroded.

Lastly, Alliger sees valuation multiples, typically a multiple of future earnings, as in-line with “the normal historical bands for this sector.” He believes that this sets the stocks up well to appreciate if there is any drawdown on truck capacity resulting in a corresponding increase in spot TL rates.

Alliger said a typical freight downturn lasts four to six quarters and that the TLs have already seen two quarters of deteriorating conditions. He outlined how transport stocks tend to increase “about halfway through a poor fundamental period” as Class 8 orders remain stagnant, spot rates are negative and contractual rates have begun to move into negative territory. He believes that the criteria for all three metrics have been met, suggesting that a bottom in the market may have formed.

“One thing we know about the truck sector, the shares tend to outperform coming out of periods of economic or capacity-related pressure, Alliger said.

In the same note, he urged clients to avoid less-than-truckload (LTL) carrier Old Dominion Freight Line Inc. (NASDAQ: ODFL) and truck freight broker Landstar System Inc. (NASDAQ: LSTR), initiating coverage with “sell” ratings.

He believes that both stocks are trading at or near premium valuations. He called out tough pricing comparisons on the horizon and soft industrial demand as reasons to avoid Old Dominion and said that weak TL spot pricing was a headwind for Landstar.