“Value,” the great Charles Dow wrote a century ago, “is determined by the margin of safety over dividends, the size and tendency of earnings, the soundness of the balance sheet and of operating methods, and general prospects for the future.”
Let’s apply Dow’s timeless wisdom to transportation stocks. While profit warnings and a weakening economy may have tarnished their near-term prospects, you can still find value in this sector — if you know where to look.
It’s not news that transportation companies are facing strong headwinds now. The Dow Jones Transportation Average is down about 15% year-to-date. Plummeting coal volumes are punishing railroads, while driver shortages and a slowdown in global trade are chilling the outlook for truckers and package delivery giants.
But that doesn’t mean investors should automatically steer clear of transportation stocks — particularly those with a strong overall value proposition.
A day after global transportation bellwethers FedEx (NYSE:FDX) and UPS (NYSE:UPS) both made news, it’s a good time to revisit the sector. Both companies’ strategic initiatives are aimed at boosting profitability and coping with myriad pressures in a global shipping market that’s in transition.
FedEx and UPS have good business models and solid fundamentals, and appear built to last based on Dow’s criteria of value. That’s true even though near-term challenges are likely to pressure earnings and margins, and both companies have lowered their profit forecasts for the remainder of the year. But that doesn’t mean they’re the sector’s best bets.
FDX shares rose about 5% on Wednesday after the company announced an aggressive cost-cutting program aimed at boosting annual profit $1.7 billion by 2015. With more former Express customers weaning themselves off premium overnight deliveries, FDX plans to pare back those operations, cut jobs and add more fuel-efficient aircraft and vehicles to its fleets.
Investors gave FDX’s cost-cutting plan two-thumbs up on Wednesday, sending the stock more than 5% higher. With a $26.6 billion market cap, the stock is trading around $90, with an attractive forward P/E of 11 and a price-to-earnings growth (PEG) ratio of 1, indicating that it’s fairly valued.
FDX pays a safe — but scant — 0.6% dividend yield. However, it revised its earnings forecast downward last month and could see its first year-over-year quarterly profit drop since 2009.
Headwinds are battering UPS, too. Reports emerged on Wednesday that its $6.7 billion bid to acquire Dutch delivery company TNT Express could be blocked by EU regulators, who fear the deal could impair package-delivery competition.
UPS, which will next report earnings on Oct. 23, forecasts the economic outlook in Europe to remain dicey for the rest of this year and into 2013. However, its planned acquisition of TNT would give Brown the opportunity to profit from commerce growth within the 27 EU member nations. It will continue to leverage its size and technology focus to enhance its competitive position globally.
At a $69.3 billion market cap, UPS is trading around $72. Its forward P/E of over 14 and PEG ratio of over 1.4 indicate it could be in the overbought range. With its 3.1% current dividend yield and more than $4 billion in free cash flow, Brown is poised to remain the 800-pound gorilla in this market for the long haul — despite today’s difficulties.
Bottom Line: Neither FDX nor UPS has been flying under the radar, so most of the short-term upside — and downside — is pretty much priced in. Here are four other transportation stocks that might be better to buy now before earnings:
JB Hunt (NASDAQ:JBHT). Analysts expect JBHT, which reports after the market closes today, to post earnings per share of 67 cents. The company’s competitive edge is in its powerhouse “intermodal” operations — handling cargo in containers that can travel by ocean, road or rail. JB Hunt is betting big on intermodal: It accounts for nearly 70% of revenue and is offsetting some sluggish growth in its truckload and dedicated contract businesses.
JB Hunt has one of the largest market caps in the trucking industry at about $6.4 billion. Trading around $54.50, the stock has a PEG ratio of 1.2, which indicates it could be overvalued. But it also has a secure dividend yield of 1%. The forward P/E of over 18 is higher than I’d like, but the company is well positioned to take advantage of 5% to 6% growth in intermodal freight volume this year. My price target on JBHT is $59.50.
CSX (NYSE:CSX). The King of Value Investors, Warren Buffett, loves railroads — and when his Berkshire Hathaway (NYSE:BRK.A) bought Burlington Northern Santa Fe back in 2009, that move boosted share prices throughout the freight rail sector. Analysts expect CSX, which next reports on Oct. 16, to post earnings of 44 cents a share. That’s not bad considering that coal volumes, which account for almost a third of CSX’s business, have tumbled precipitously due to mild weather and cheap natural gas.
While domestic coal shipments aren’t expected to rebound anytime soon, that’s not the whole story. CSX, which operates the largest freight rail line in the eastern U.S., will experience growth from foreign coal shipments, autos and international container volumes, as InvestorPlace’s Sam Collins points out. With a market cap of nearly $22 billion, CSX is trading around $21. It has a PEG ratio of less than 0.8, a forward P/E under 11 and it pays a current dividend yield of 2.6%. My price target on CSX is $25.
Union Pacific (NYSE:UNP). Next week is a big week for freight rail: After CSX, the nation’s largest freight railroad, Union Pacific, reports earnings on Oct. 18. Analysts are expecting EPS of $2.19 a share and recently forecast UNP’s long-term earnings growth at more than 15%.
Union Pacific also is well positioned to reap rewards from intermodal growth — particularly since such shipments on U.S. railroads have hit record volumes in recent weeks, according to the Association of American Railroads (AAR). In the face of higher diesel fuel costs, UNP also is evaluating whether retrofitting locomotives to run on natural gas makes sense to reduce the industry’s largest expense.
With a market cap of nearly $57.3 billion, Union Pacific is trading around $121. It has a PEG ratio of 1, indicating that the stock is fairly valued, and a forward P/E of less than 13. It has a current dividend yield of 2%. My price target on UNP is $130.
Ryder (NYSE:R). The truck-leasing company will report earnings on Oct. 23, and analysts expect EPS of $1.18 for the quarter ended Sept. 30. As the industry leader, Ryder has a different business model than most other transportation companies, but its innovation is a key reason its earnings (and dividends) are likely to keep rolling.
The lion’s share of Ryder’s business comes from its Fleet Management Solutions unit, which includes commercial rentals and generates fuel service profits. The company also competes on the logistics side with its Supply Chain Solutions unit, and its Dedicated Contract Carriage provides trucks and drivers on a contract basis.
With a market cap of nearly $2.2 billion, Ryder is trading around $42. The stock has a PEG ratio of 1, indicating that it’s fairly valued. But in a transport sector with premium valuations, R’s forward P/E of less than 9 is very attractive, as is its 2.9% current dividend yield.
Even with the current economic challenges, I think Ryder has more room to run. My price target is $52.
As of this writing, Susan J. Aluise did not hold a position in any securities mentioned here.