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Transport Services Stock Outlook: High Costs a Major Worry

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The Zacks Transportation Services Industry includes providers of logistics, leasing and maintenance services to transporters.

Strong U.S. macroeconomic fundamentals and a surge in manufactured and retail goods along with an improving global economy bode well for the entire transportation sector. Consequently, companies offering equipment financing and leasing, logistics and supply chain management services to the broader industry are also reaping the benefits.

Increased freight demand is a tailwind for third-party logistics companies like C.H. Robinson Worldwide, Inc. (CHRW - Free Report) .  Higher freight rates, robust shipping demand and lower tax rates act as tailwinds to service providers.

However, a rise in fuel costs is a concern for the companies. This is because expenses associated with oil are considered to be one of the major input costs for any transportation player. Therefore, the recent upsurge in fuel costs (oil prices have risen more than 20% year to date) does not augur well for stocks in the space. Expenses on the labor front too limit bottom-line growth.

Additionally, car rental companies like Hertz Global Holdings, Inc. (HTZ - Free Report) , which form part of the transportation services industry, are suffering from headwinds like intense competition, high costs and pricing pressure due to low used-car prices.

Industry Underperforms on Shareholder Returns

Judging by shareholder returns over the past year, it seems the improving domestic economy and the resultant robust freight demand weren’t enough for instilling investors’ confidence as far as the industry’s growth prospects are concerned.

Headwinds like high fuel and labor costs, pricing pressure and intense competition for car rental players have contributed to investors’ pessimism surrounding the space.

The Zacks Transportation Services industry, which is a 24-stock group within the broader Zacks Transportation Sector, has underperformed both the S&P 500 and its own sector over the past year.

While the stocks in this industry have collectively gained 2.7%, the Zacks S&P 500 Composite and Zacks Transportation Sector have rallied 14.4% and 6.3%, respectively.

One-Year Price Performance

 

Transport Services stocks Not Trading Cheap

Despite the industry’s underperformance over the past year, the valuation does not look cheap now. 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 15.82, below the highest level of 16.75 but above the median level of 15.23 over the past year.

The space is also expensive when compared with the market at large, as the trailing 12-month EV/EBITDA ratio for the S&P 500 is 11.77 and the median level is 11.43.

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 10.09 and the median level of 9.69 for the same period are significantly below the Zacks Transportation Services industry’s respective ratios.

Enterprise Value/EBITDA (TTM)

 

 

While this might suggest little room for an upside, investors should note that the industry has historically traded at a premium to its sector.

Underperformance May Continue Due to Bleak Earnings Outlook

The strong balance sheets of most major companies in the space have enabled them to engage in shareholder-friendly activities. For instance, Expeditors International of Washington Inc.  (EXPD - Free Report) hiked its semi-annual cash dividend to the tune of 7.1% in May. Additionally, the surge in freight demand and higher freight rates bode well for well for the service providers to the transport industry.

But what really matters to investors is whether this group has the potential to perform better than the broader market in the quarters ahead. While the above ratio analysis shows that there is a solid value-oriented path ahead, one should not really consider the current price levels as good entry points unless there are convincing reasons to predict a rebound in the near term.

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 its stock performance.

The Price & Consensus chart for the industry shows the market's evolving bottom-up earnings expectations for it as well as 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 Services 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 $1.51 EPS estimate for the industry for 2018 is not the actual bottom-up dollar estimate for every company in the Zacks Transportation Services 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 projected number has evolved recently. 

Current Fiscal Year EPS Estimate Revisions

 

 

As you can see here, the $1.51 EPS estimate for 2018 is down from $1.57 at the end of April and $1.83 this time last year. In other words, the sell-side analysts covering the companies in the industry have been steadily lowering their estimates. 

Zacks Industry Rank Indicates Bleak Prospects

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates continued underperformance in the near term.

The Zacks Transportation Services industry currently carries a Zacks Industry Rank #177, which places it at the bottom 31% 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.

In fact, the basis of this bearish outlook could be the steady downward trend in top line that the service providers to the transport industry have been showing since the beginning of 2016.

 

 

Transport Services Stocks Promise Long-Term Growth

While the near-term prospects look unwelcoming for investors, the long-term (3-5 years) EPS growth estimate for the Zacks Transportation Services industry appears promising. The group’s mean estimate of long-term EPS growth rate has been increasing since May 2018 to reach the current level of 11.9%. 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-terms EPS growth could be an increase in gross profit for the industry since the beginning of 2017.

 

 

Bottom Line

Even though factors like a surge in freight demand, favorable freight rates and lower tax rates are positives for the sector and might contribute to long-term growth, we believe that the players in the Zacks Transportation Services industry will struggle in the short term due to increased costs, high debt levels and other headwinds.

With the near-term prospects of the industry looking dim, below are two stocks that we could recommend investors to steer clear of.

Dynagas LNG Partners LP (DLNG - Free Report) owns and operates LNG carriers that are employed on multi-year contracts with international energy companies. The stock has shed 27.7% of its value year to date. The Zacks Consensus Estimate for the current-year EPS has been revised 7.1% downward over the last 60 days. The stock carries a Zacks Rank #4.

Price and Consensus: DLNG

 

 

Hertz Global Holdings, based in Estero, FL, is a key player in the vehicle rental industry. Its subsidiary, The Hertz Corporation, is responsible for the operation of vehicle rental services under the Hertz, Dollar and Thrifty brands. The stock has shed 33.2% of its value on a year-to-date basis. The Zacks Consensus Estimate for loss for the current-year has widened significantly over the last 60 days. The stock carries a Zacks Rank #4.

Price and Consensus: HTZ

 

 

However, there are a few stocks in the Zacks Transportation Services industry, which investors can pick based on their solid growth prospects. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Expeditors International of Washington, based in Seattle, WA, is a leading third-party logistics provider. This Zacks Rank #1 stock has gained 15.5% on a year-to-date basis. The Zacks Consensus Estimate for the current-year EPS has been revised 3.3% upward over the last 60 days.

Price and Consensus: EXPD

 

 

Hawaii-based Matson Inc. (MATX - Free Report)    operates as an ocean transportation and logistics company. It offers shipping services in Hawaii, Guam, and Micronesia islands and expedited service from China to southern California. This Zacks Rank #1 stock has gained 17.5% on a year-to-date basis. The Zacks Consensus Estimate for the current-year EPS has been revised 0.9% upward over the last 60 days.

Price and Consensus: MATX

 

 

 

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