Friday’s profit warning from UPS (UPS - Analyst Report) and today’s earnings short fall from JB Hunt (JBHT - Analyst Report) put the transport sector in the spotlight. The results may cause a review of the profit outlook in the freight/transportation sector, and the market to think about making a U-turn. UPS noted its profits had been hurt by customers trading down to lower cost shipment methods, slower industrial production, and overcapacity in the airfreight market. The slowdown in international business is not surprising given soft export growth numbers from China and India, and continued sluggish economic growth in Europe. JB Hunt reported that its truck segment saw a 20% drop in revenues due to a smaller fleet and lower utilization. The profit results prompt an examination of the Cass Shipping index, which monitors freight shipment volume, for insight into the transportation industry’s health.
Shipment and economic activity are slow:
The Cass Shipment index displayed strength in Q2 relative to Q1 averaging 1.12 compared to 1.08, but the three month average of the year over year change in the Index was -1.0% in June compared to +0.7% at the end of March. As the graphic implies, growth in shipment activity has been relatively flat since the summer of 2011 and does not appear to have strong forward momentum. Despite the economic expansion, the Federal Reserves’ index of industrial production has not exceeded the peak prior to the Great Recession in late 2007. Further, the manufacturing index has been flat to lower since February 2013, showing a pause in growth. The pace of economic activity has not been helpful to the freight sector and it is not surprising that UPS and JB Hunt disappointed investors with their profit results. The graphic also highlights the loose, but positive correlation between trucker stock prices and the Cass Shipment index.
The market is optimistic on earnings:
The table below displays the 2013 and 2014 Zacks earnings per share consensus and the number of upward revisions to EPS estimates in the past thirty days for four select trucking companies. Knight Transport (KNX - Snapshot Report), Old Dominion (ODFL - Snapshot Report), Arkansas Best , and Covenant Transportation (CVTI - Snapshot Report) were examined. All the companies have a Zacks Rank #2 (Buy). None of the four companies had seen their EPS estimates reduced in the past 30 days. The agreement among analysts leans constructive for the profit outlook and runs against the recent profit warning from UPS and the short fall from JB Hunt. Arkansas Best has seen the strongest movement in EPS forecasts. The enthusiasm toward the sector seems misplaced based on the most recent data points.
The next table displays the estimated 2013 and 2014 PE ratios along with the average 12 month forward PE ratios based on year end values over the past five years. The valuation proposition is unexciting in the sector. The stocks look more attractive on 2014 EPS than 2013 EPS consistent with the overall view for profits to continue to rise in 2014. The PE ratio levels are generally above the minimum and well below the maximum 12 month forward estimates. Given the current guidance and slow global economic expansion, it may be hard for the sector to see PE ratio expansion.
What does it mean?
The transport sector has traded firmly in recent sessions after breaking above a trendline from the May highs. The graphic displays a price chart of the ishares Transportation ETF (IYT - ETF report). From a technical perspective, recent price action looks like consolidation to push higher and a set up for a test of the May high. The ETF seems to be ignoring signs of weakness in the trucking sector given news from JB Hunt and UPS, but the weight of rail names may be providing cover for weak trucking and air shipment results. Union Pacific (UNP - Analyst Report) and KC Southern (KSU - Analyst Report) account for 22% of the ETF’s holdings. Both Union Pacific and KC Southern are Zacks Rank #3 (Hold). Watch to see if earnings estimates revisions stop rising in the trucking sector and make a U-turn lower. Further, the results could sober the outlook for profits in the industrial sector in general. The combination of recent corporate results and the Cass Shipment index suggest the transport sector faces headwinds and indicate the economy is not supportive to vibrant profit growth. . A breakdown in the transport sector would likely make it more difficult for the overall market to continue with its rally. Rails may be the lynchpin of the transportation sector’s health. Union Pacific and KC Southern release their profits on July 18th and July 19th respectively.