Rebound in Trucking Company Share Prices May Be Fragile, Analysts Warn

This story appears in the June 29 print edition of Transport Topics.

Trucking stocks have rallied over the past four months despite the sour U.S. economic conditions, but the recent rise in shares is a fragile one, analysts warned.

Between March 9 and mid-June, all but three of the 36 publicly traded fleets’ shares gained value. Con-way shares more than doubled in value, and Arkansas Best Corp. rose 88% to lead the rise among individual companies. The Standard & Poor’s Trucking Index gained more than 61% over the period, outpacing the benchmark Standard & Poor’s 500, which climbed 42%.

“The market [for trucking stocks] has to take a rest here,” Robert W. Baird analyst Jon Langenfeld told Transport Topics. “I’m not going to say the stocks are wildly overpriced, but it does feel like the stocks are reflecting a better environment than we are seeing.”

Wolfe Research founder Ed Wolfe said in an investor note that he’s worried freight company stocks are “increasingly extended,” because they’ve gained faster than the market as a whole at a time when the economy is still struggling.

Other analysts warned that weak second-quarter earnings reports could take share prices down as well. Even though shares have risen since early March, they have fallen with a thud since this time last year. Twenty-eight of 36 publicly traded fleets’ shares are trailing last June’s price level.

Prices for six truckload fleets and two less-than-truckload fleets topped mid-June 2008 levels, with Covenant Transportation Group posting the biggest percentage gain at 44%. The next-largest gains, in order, were Saia (28%), Marten Transport (23%), USA Truck (19%) and Old Dominion Freight Line (13%).

At this time last year, three-fourths of the 36 publicly traded fleets’ stock prices were higher than mid-2007 levels.

The reduced business levels that have savaged share prices are reflected in American Trucking Associations’ tonnage index, which has fallen about 15% in the past 12 months. In addition, the benchmark Standard & Poor’s 500 index lost more than 40% of its value between September and March.

“It was as if people stopped shipping,” Dahlman Rose analyst Jason Seidl told TT. “The U.S. economy was in a free fall, and the response by shippers was to cut back everywhere they could, which sent freight volumes — and stocks — down even further.”

Some of the biggest trucking names — for example, UPS Inc., No. 1 on the Transport Topics 100 list of the largest U.S. and Canadian for-hire carriers, and competing package carrier Fed-Ex Inc., which ranks No. 2 on TT’s list — have led the decline. UPS has fallen 26% and FedEx 38% over 12 months.

The share price of YRC Worldwide, No. 4 on the TT 100, plummeted 83%, a rate of decline exceeded only by intermodal operator Pacer International, whose shares lost 88% of their value over that period.

While year-to-year compari-sons are mostly unfavorable, the trucking share rally that also boosted Knight, Heartland Ex-press and Werner Enterprises shares above 2008 levels coincided with a rally in the S&P 500, which reached a 12-month low on March 9.

Langenfeld said he is encouraged that the steep drop in 2009 freight at least has leveled off.

“The freight environment re-mains challenging, but demand trends (both domestic and international) appear to have stabilized at very low levels,” Langenfeld said. “Normal seasonality is a positive after the unprecedented abnormal period from the third quarter of 2008 through the first quarter of 2009.”

“Demand for truckload service appears to be rising,” Morgan Stanley analyst William Greene said in a May 29 investor note. He credited the modest improvement to a change in behavior by retailers and manufacturers that no longer are drawing down, or “destocking,” inventory.

In a June 11 report, he said that current truckload share prices are unlikely to rise much more because the expectation of an economic recovery caused the shares to rise since March.

Other analysts said they believe that trucking shares could en-counter trouble when second-quarter earnings are announced next month.

Among them is Stifel, Nicolaus & Co. analyst John Larkin, who said in an investor note June 4 that stocks are primed for a fallback.

“Volumes have not improved, pricing has intensified, and most carriers should no longer have the benefit from the lag in fuel surcharge” tied to lower diesel prices, Larkin said. “Many truckload carriers are being shown leniency from their banks, which is slowing the exit of industry capacity.”

Seidl had the same viewpoint.

“If second-quarter earnings disappoint and the economy doesn’t show measurable improvement, the group [trucking stocks] is in trouble,” Seidl said.

The key factor for investors to watch going forward is the direction of the U.S. economy, several analysts said.

“The next driver of share price appreciation is fundamental im-provement in the economy,” Langenfeld said.

Among the signs that the economy might be in the early stages of improvement were fewer initial unemployment claims, stable retail sales and a modest pickup in home sales during the first part of June. Industry trends need to turn around, too.

“Pricing needs to get better, not worse,” Langenfeld said.

At Wolfe’s recent transport conference, carriers and shippers alike indicated that prices in freight contracts have fallen 5% to 8% and prices that are arranged on spot markets, such as freight load boards, have fallen 30%.

“Pricing pressure will continue to weigh on carrier results for the next couple of quarters,” Greene said, predicting a long and slow pricing recovery.

Trucking also has to reverse double-digit 2009 freight volume declines to boost trucking shares.

“A move toward low single-digit [below 5%] contraction in volume would be a good first step,” Langenfeld said. He predicted that trend could occur in the fourth quarter of 2009 because freight volumes dropped off quickly during that period last year. Volume growth could return early next year, he said.

Still other trucking industry changes could help the stocks.

“We need to see more bankruptcies among the smaller carriers,” Seidl said, noting that fleet failures would reduce capacity and help pricing.

A total of 480 fleets failed in the first quarter, a pace that was far slower than last year, when more than 3,000 closed their doors, according to Avondale Partners research. The carrier failures last year cut industry capacity an estimated 7%.

Langenfeld said he believes fleets could be helped by capacity reductions from a different source.

“Nobody is buying trucks,” he said. “That is the one piece people are missing. That lack of buying is taking out far more capacity than bankruptcies.”

Truck sales have fallen to 25-year lows, and the overall fleet of tractors in use has remained stable, according to the latest data. The “underbuy” of new trucks that began in 2007 and should run through 2010 will be the largest source of capacity rationalization, Langenfeld wrote in a report. He estimated a 15% permanent re-duction from the reduced purchases since the 2006 peak of 369,000 units.

Investors still need to consider other factors, several analysts said, such as whether trucking share increases this year will repeat past patterns in predicting economic recoveries.

Typically, trucking shares move up six to nine months before an economic recovery actually starts, Langenfeld said, as investors buy those companies in expectation that their business will rise with the economy.

If that pattern holds true in 2009, a recovery will begin in September, because the stock prices began to rise in March.

In financial parlance, trucking stocks are known as “early cyclicals,” meaning that publicly traded fleets’ share prices rise or fall before an economic cycle changes.

But neither Langenfeld nor Wolfe thinks the pattern necessarily will repeat itself this time.

“During past downturns, signs of [economic] stabilization have often led to strong buying opportunities for early cyclicals,” Wolfe said, adding, “We don’t see this as a very viable outcome in the current cycle.”

“A key difference this time around is the severity of the freight drop, intense pressure from shippers to lower prices that fleets charge to haul freight and the extent of overcapacity,” Wolfe said.

Still another factor working against stocks is the comparison with last year, when President George W. Bush’s economic stimulus package gave a boost to June freight volumes, Morgan Stanley’s Greene noted.

ATA’s seasonally adjusted tonnage index rose 5.4% to 115.6 in June last year and has fallen almost every month since then. It’s now struggling to stay above the 100 mark.

One other key factor to watch, Seidl said, is the difference in the way market forces affect truckload and LTL markets, as well as railroads, where intermodal accounts for 40% of industry volume.

“You have seen a dramatic jump off the bottom on the LTL side,” Seidl said, referring to the share price in that sector as investors try to gauge the level of financial difficulty at YRC.

Truckload share prices also will be affected by what is called “out of cycle” pricing by shippers, Seidl and other analysts said. Earlier this year, for example, shippers requested new bids from carriers before their contracts expired in a bid to take advantage of lower rates.

It was that “out of cycle” pricing that hit truckload carriers particularly hard, leading to rate declines that were highlighted at Wolfe’s recent meeting.

In the case of railroads, whose shares have dropped 25% or more this year — and up to 50% compared with this time last year — the reasons are easy to spot, analysts say.

“A steady drip of ghastly carload data combined with the [stock] market’s concern about increased regulation has caused the rail stocks to lag many other transport names in the recent market rally,” Credit Suisse analyst Chris Ceraso wrote in an investor note.

The “ghastly” rail data include a 20% drop in carload shipments during the first five months of the year, a decline almost twice as much as the drop in ATA’s tonnage index so far this year. Intermodal traffic fell 16% over that same period.

On the legislative side, concern is tied to shippers’ efforts to get a bill passed that could increase rail-rate regulation and lower prices as well as profits.

The outlook for such legislation is uncertain now for three reasons: No active legislation has been voted on yet, the congressional calendar is crowded and talks are continuing between railroads and some shippers on a compromise approach.