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Where Will Transportation ETFs Go From Here?

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After being stressed by freezing temperatures in the first quarter, the transportation sector has been on the smooth ride over the past several months. This is especially true given that transportation gets busier when economic activity picks up. Solid retail, manufacturing and labor data act as major tailwinds to the broad growth, indicating strong demand for movement of goods across many sectors.

In fact, the Dow Jones Transportation Average and two ETFs – iShares Dow Jones Transportation Average Fund ((IYT - Free Report) ) and SPDR S&P Transportation ETF ((XTN - Free Report) ) – touched an all-time high last week. However, plunging stock prices for most of the transportation companies despite the earnings beat stalled the rally over the past five days (read: 4 Recent ETF Winners in Focus).

In particular, earnings from Union Pacific (UNP - Free Report) , Norfolk Southern Corp (NSC - Free Report) , C.H. Robinson Worldwide (CHRW - Free Report) , Delta Air Lines (DAL - Free Report) and United Continental (UAL - Free Report) have been encouraging. On the other hand, an earnings miss and a sluggish outlook from the bellwether United Parcel Service (UPS - Free Report) dampened investors’ mood and weighed upon the sentiments of the broad transport sector.

Transportation Earnings in Focus

UNP, the U.S. largest railroad, reported earnings of $1.43 per share, a penny ahead of the Zacks Consensus Estimate and 21% higher than the year-ago earnings. Revenues climbed 10% year over year to a record $6.01 billion, trumping our estimate of $5.98 billion. The robust performance was driven by higher shipments of agricultural products and coal. Shares of UNP lost nearly 3% to date, post earnings announcement.

Another major railroad, NSC, posted strong earnings of $1.79 per share comfortably beating our estimate by a nickel and improving from the year-ago earnings by 33 cents. Revenues rose 9% year over year to a record $3.042 billion and were well above the Zacks Consensus Estimate of $3.027 billion. Continued strength across all business segments and substantial improvement in operating ratio drove the results. The share price of NSC has dropped about 3.7% since the earnings announcement (read: Industrial Stock Earnings Fail to Impress These ETFs).

CHRW, the freight transportation services and logistics solutions provider, also topped the Zacks Consensus Estimate on both bottom and top lines. Earnings per share of 80 cents and revenues of $3.5 billion surpassed our earnings estimate of 77 cents and revenue estimate of $3.47 billion. The stock rallied 6.4% the day after the company announced earnings on July 29 after the closing bell.

Earnings at Delta came in at $1.04 outpacing our estimate by a penny and revenues were $10.6 billion, $0.03 billion above our estimate. On the other hand, earnings of $2.34 per share at United Continental strongly beat the Zacks Consensus Estimate of $2.22 per share while revenues of $10.33 fell short of our estimate of $10.39 billion. Both stocks are up 0.4% and 2.1%, respectively, to date post earnings announcement.

The world's largest package delivery company – UPS – missed on the bottom line by 3 cents and slashed its full-year outlook on expected increase in capital spending ahead of the busy holiday shopping season. The company now expects earnings per share in the range of $4.90–$5 compared with the previous expectation of $5.05–$5.30.

However, the Zacks Consensus Estimate of $4.93 for 2014 seems attainable. Further, revenues of $14.27 billion topped the Zacks Consensus Estimate of $14.07 billion. Shares of UPS dropped 3.7% on the day of earnings announcement on July 29 but slightly recovered the next day with modest gain of 0.50%.

IYT in Focus

The ETF tracks the Dow Jones Transportation Average Index, giving investors exposure to the small basket of 21 securities. The fund has a certain tilt toward large cap stocks at 43% while mid and small caps account for 39% and 17% share, respectively, in the basket (see: all the Industrials ETFs here).

Further, the product puts 64.6% of assets in the top 10 firms, suggesting their heavy concentration and dominance with respect to returns. From a sector perspective, railroad takes the top spot at 24.19%, while delivery service (21.89%), trucking (19.82%) and airlines (14.07%) round off to the top four.

The fund has accumulated $1.2 billion in AUM while sees good trading volume of around 325,000 shares a day. It charges 43 bps in fees and expenses and was down 2.2% in the last five trading sessions.

XTN in Focus

This fund uses equal weight methodology to each security by tracking the S&P Transportation Select Industry Index. Holding 48 stocks in its basket with AUM of $243.7 million, each security accounts for less than 3% of total assets. The ETF is skewed toward small caps at 46% while mid and large caps account for 32% and 22% share, respectively (read: Guide to Small Cap Growth ETFs Investing).

The product is heavily exposed to trucking and airlines as these make up roughly 62% of the total while airfreight & logistics and railroads account for 20% and 12.3% share, respectively. The fund charges 35 bps in fees per year from investors and trades in a light volume of less than 28,000 shares a day. XTN lost about 2.8% over the past five days.

Bottom Line

Though the two funds have been sliding lately, they are crushing the broad sector (XLI) and broad blue-chip (DIA) funds by wide margins. This is because IYT and XTN gained nearly 12.9% and 14.9%, respectively, compared to gains of only 2.1% for XLI and 3% for DIA.

In addition, the products have a top Zacks ETF Rank of 1 or ‘Strong Buy’ with a Medium risk outlook, suggesting that the outperformance will continue in the coming months as well. Further, given an accelerating job market and improving economic growth, investors should definitely tap the beaten down stock prices by stuffing transportation ETFs into their portfolio.

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