The bulls are coming out in support of truckload (TL) carriers, kind of. Several equity analysts are using a recent positive inflection in TL volumes, a belief that fundamentals aren't getting materially worse, and attractive valuation multiples to become more positive on the stocks.
Seaport Global stock analyst Kevin Sterling upgraded Heartland Express (NASDAQ: HTLD) to a buy on Sept. 5 following the company's acquisition of Millis Transfer. Sterling contends, "consensus estimates are just too low." He noted that his 22.7x price-to-earnings (P/E) multiple on his 2020 earnings per share (EPS) estimate is in-line with the carrier's 15-year historical average of 22x.
Typically, stock prices are driven by a multiple of future earnings. P/E multiples are most commonly used and a key valuation metric for transportation stocks.
Sterling continued in a note to clients answering his own question; "is demand actually improving?" He cited a truck capacity correction as Class 8 orders fell for their 10th consecutive month, down 80% year-over-year to a sub-11,000 level in August. The August 2018 comparison is difficult as that was the peak for order activity at more than 53,000 units.
Class 8 net orders – ORDERS.CL8 – SONAR
The report also highlighted an increase in carrier bankruptcies, which should trim some of the truck capacity overhang. "The larger carriers tell us that smaller carriers who are exposed more heavily to the spot market and faced with higher insurance costs and the switch from AOBRDs (automatic onboard recording devices) to ELDs (electronic logging devices) may continue to exit the industry," said Sterling.
At the time, Sterling was the only analyst recommending HTLD. Sterling has five of six covered names rated at buy – Covenant Transportation Group (NASDAQ: CVTI), Daseke, Inc. (NASDAQ: DSKE), HTLD, Knight-Swift Transportation (NYSE: KNX) and Marten Transport (NASDAQ: MRTN).
On the same day, Susquehanna analyst Bascome Majors initiated coverage on KNX and Schneider National, Inc. (NYSE: SNDR) with "positive' ratings and reiterated his positive stance on J.B. Hunt (NASDAQ: JBHT) and neutral stance on Werner Enterprises Inc. (NASDAQ: WERN). Majors stock call had more to do with favorable stock valuations than a meaningful uptick in TL fundamentals.
Majors is a little more bearish on the space saying that TL contract rates turned negative in July as spot rates have fallen for a full year now. He believes that rate declines will "likely persist into 2020." He believes that the optimism around the TL group is overdone and that the mentality that the space has seen the last of guidance cuts from management teams may be optimistic. He highlighted that his earnings estimates are below current consensus estimates.
Other analysts have used recent guidance cuts as well as declines in contractual TL rates, which remained higher year-over-year in early 2019 given favorable comparisons, as reasons to become more bullish on the group. The thought is that as contractual rates (the large bulk of how the publicly traded TLs transact freight movements with shippers) move negative and converge with spot rates, the spot market becomes more attractive, potentially forming a floor for future contractual rate negotiations as contractual rates (typically one year in duration) are based off the current supply-demand balance in the spot market.
With contractual rates negative and guidance/earnings estimates reduced, many analysts believe that this is the time to become more constructive on the TLs.
Majors went on to say that his analysis shows that "TL valuations typically bottom before contract rates turn negative, and shares begin to consistently outperform in the third quarter post-inflection." Majors said that there is no certainty that the late-May/June bottom for TL stock prices was the actual bottom for this cycle. He believes that downside is limited and that earnings multiple expansion should drive outperformance in 2020. "Hence, we recommend moderate "risk-on" positioning today," he said.
It's important to note that Majors' "recommendation toward truckload is not a structural view, but rather a cyclical call based on our analysis of how profits, valuations, and shares move through negative truckload pricing cycles." His call contends that the downside risk to TL stocks is limited as he believes that valuation multiples have bottomed.
Majors did mention some TL green shoots. "While most truckload news is still bad news, our realtime measure of truckload contractual volume inflected positively Y/Y in late July, with low-to-mid single digit growth persisting through the Labor Day holiday in early September."
FreightWaves' Outbound Tender Volume Index (OTVI.USA), an index value which moves in proportion to the total observable outbound tender volume across the country, has seen a bump in volumes as well.
Outbound Tender Volume Index – OTVI.USA – SONAR
KeyBanc analyst Todd Fowler upgraded both HTLD and MRTN to overweight on Sept. 9, and reiterated overweight ratings on KNX and WERN.
According to market news provider theflyonthewall.com, Fowler "has increased conviction in stabilizing truckload dynamics on more seasonal trends and reduced incremental supply. His channel checks indicate lower demand and available capacity third quarter to date, which he notes is largely in line with expectations. However, pricing outlooks have stabilized."
Morgan Stanley analyst Ravi Shanker has overweight ratings on four of his five covered TLs – KNX, U.S. Xpress (NYSE: USX) SNDR and WERN. In a note to clients, he said that both indices he compiles on TL freight and sentiment "have seen surprise outperformance in a seasonally weak August potentially setting up better 2H19/2020 than expectations." He said that spot dry van rates have been stable since August, but he has concerns that tough pricing comps through the end of 2019 could impact contract negotiations in early 2020.
He may have summed it up best, "it's clear things aren't necessarily getting worse – but are they getting better?"
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