Why Is RLI Corp. (RLI) Up 3.4% Since Last Earnings Report?
The Zacks Transportation - Air Freight and Cargo industry includes players that provide air delivery and freight services. In fact, the industry is dominated and defined by package delivery majors like FedEx Corporation (FDX) and United Parcel Service, Inc. (UPS).
The rapid e-commerce growth is a huge positive for the sector participants. Moreover, the fact that the U.S. economy is in good health at the moment is a positive for the entire transportation space, and the players in the air freight and cargo sub-group are no exception. Robust freight activity in the United States is an added positive. Moreover, the Tax Cuts and Jobs Act, which reduces corporate tax rate significantly, is a huge positive for these companies.
Despite the positives, players in the air freight and cargo industry are not bereft of headwinds. Companies in the space invest significantly in improving their infrastructure and upgrading facilities.
Though bullish on such efforts, such investments are limiting bottom-line growth. For instance, capital expenditure at UPS for 2018 is projected between $6.5 billion and $7 billion.
Additionally, high delivery costs might hurt its bottom line.Escalating trade war tensions between China and the United States also remain a concern. Moreover, technological failures like the TNT Express cyberattack at FedEx last year have the potential to cripple operations.
Industry Returns Lag S&P 500’s Yield in a Year
The Zacks Transportation - Air Freight and Cargo industry, which is a six-stock group within the broader Zacks Transportation Sector, has underperformed the benchmark S&P 500 group in a year’s time. It has, however, outpaced the sector in the same time period.
While the stocks in this industry have collectively rallied 12.7%, the Zacks S&P 500 Composite and Zacks Transportation Sector have gained 20.9% and 9.8%, respectively.
One-Year Price Performance
Despite the industry underperforming the market at large, its valuation is not expensive when compared with the S&P 500. One might get a good sense of the industry’s relative valuation by looking at its EV-to-EBITDA (enterprise value to earnings before interest, tax, depreciation and amortization) ratio, which is often used to value the industry, given their significant debt levels and high depreciation and other expenses.
This valuation metric takes into account not just equity but also the level of debt. For capital-intensive companies, EV/EBITDA is a better valuation metric because it is not influenced by changing capital structures and ignores the effect of noncash expenses. The industry currently has a trailing 12-month EV/EBITDA ratio of 11.74, below the highest level of 12.7 but above the median level of 11.59 over the past year.
The trailing 12-month EV/EBITDA ratio for the S&P 500 is 11.78 and the median level is 11.46.
Enterprise Value/EBITDA (TTM)
However, as transportation stocks have unique characteristics, a comparison of the group’s EV/EBITDA ratio with that of its border sector is probably the best approach. Such a comparison ensures that the group is trading at a premium. The Zacks Transportation Sector’s trailing 12-month EV/EBITDA ratio of 10.64 and the median level of 9.83 for the same period are below the Zacks Transportation Services industry’s respective ratios.
Enterprise Value/EBITDA (TTM)
While this might suggest little room for upside, investors should note that the industry has historically traded at a premium to its sector.
Earnings Outlook Looks Encouraging
Solid e-commerce growth is a huge positive for the companies in the space and should drive growth. Moreover, the upbeat freight scenario is an added positive for the providers of air delivery and freight services. In fact, the Cass Freight Shipments Index surged 10.6% in July 2018 to its highest settlement since 2007. Moreover, huge savings due to the new tax law may prompt a rise in the frequency of shareholder-friendly activities.
But what really matters to investors is whether this group has the potential to perform better than the broader market in the quarters ahead. One reliable measure that can help investors understand the industry’s prospects for a solid price performance is the earnings outlook for its member companies. Empirical research shows that a company’s earnings outlook significantly influences the performance of its stock.
The Price & Consensus chart for the industry below shows the market's evolving bottom-up earnings expectations for it and the industry's aggregate stock market performance. The red line in the chart represents the Zacks measure of consensus earnings expectations for 2019, while the light blue line represents the same for 2018.
Price and Consensus: Zacks Transportation - Air Freight and Cargo industry
This becomes even clearer by focusing on the aggregate bottom-up EPS revisions trend. The chart below shows the evolution of aggregate consensus expectations for 2018.
Please note that the $8.43 EPS estimate for the industry for 2018 is not the actual bottom-up dollar estimate for every company in the Zacks Transportation - Air Freight and Cargo industry, but rather an illustrative aggregate number created by our proprietary analytics model. The key factor to keep in mind is not the earnings per share of the industry for 2018, but how this projection has evolved recently.
As you can see here, the $8.43 EPS estimate for 2018 has been revised upward to the tune of 12.1% on a year-over-year basis. However, the same has remained static since the end of June, reflecting the cautious approach of analysts as stocks in the space grapple with headwinds that might impact their results in the short term.
Zacks Industry Rank Unfavorable
The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates underperformance in the near term as the industry battles high costs and uncertainty due to the escalating trade war tensions between China and the United States.
The Zacks Transportation - Air Freight and Cargo industry currently carries a Zacks Industry Rank #222, which places it at the bottom 13% of more than 250 Zacks industries. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.
Transport Air Freight and Cargo Stocks Promise Long-Term Growth
While stocks in the space are currently struggling due to high costs and mounting trade war-related tensions among other issues, as highlighted by an unimpressive Zacks Industry Rank, the long-term (3-5 years) EPS growth estimate for the industry appears promising.
The group’s mean estimate of long-term EPS growth rate has been increasing since June 2018 to reach the current level of 12.1%. This compares to 9.8% for the Zacks S&P 500 composite.
Mean Estimate of Long-Term EPS Growth Rate
In fact, the basis of this long-term EPS growth could be the steady increase in top line that stocks in the group have been showing since the beginning of 2016.
We believe that the players in the Zacks Transportation Air Freight and Cargo industry will struggle in the short term mainly due to increased expenses, issues related to the U.S.-China trade war, the long-term prospects are encouraging for investors in the space.
Even though investments to upgrade facilities might limit bottom-line growth in the short term, the same is anticipated to bear fruit over a longer time horizon. E-commerce should also aid the companies’ top lines.
Overall, the industry might not be able to tide over the challenges in the near term and therefore none of the stocks in the space currently hold a Zacks Rank #1 (Strong Buy). However, below is a stock that has been witnessing positive earnings estimate revisions and carries a Zacks Rank #2 (Buy).
(You can see the complete list of today’s Zacks #1 Rank stocks here.)
Atlas Air Worldwide Holdings, Inc. (AAWW): The stock of this Purchase, New York-based company has gained 4.9% on a year-to-date basis. The Zacks Consensus Estimate for the current-year EPS has been revised 7.1% upward over the last 60 days.
Price and Consensus: AAWW
As mentioned throughout, there are a number of reasons to worry about the industry’s performance in the near to medium term. So, it would be prudent to stay away from such stocks for now. Stocks carrying an unfavorable Zacks Rank are particularly expected to underperform.
FedEx Corporation : The stock of this Memphis, TN, package delivery company has shed 2.4% of its value over the past three months. The Zacks Consensus Estimate for the current-year EPS has been revised 0.2% downward over the last 60 days. The stock carries a Zacks Rank #4 (Sell).
Price and Consensus: FDX
Avianca Holdings S.A. (AVH): The stock of this Panama City, Panama, based- company has shed 28.3% of its value over the past three months. The Zacks Consensus Estimate for the current-year EPS has been revised 42.6% downward over the last 60 days. The stock carries a Zacks Rank #5 (Strong Sell).
Price and Consensus: AVH
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United Parcel Service, Inc. (UPS) : Free Stock Analysis Report
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