Investors Wait for Economic Growth to Reignite Trucking

By Jonathan S. Reiskin, Associate News Editor
This story appears in the June 25 print edition of Transport Topics.

Investors in trucking stocks, who watched share prices fall in the second half of 2006 and rebound this spring, are now waiting for a verdict on the U.S. economy. The key question before investors, stock analysts say, is whether a desired surge in economic growth will lead to reigniting valuations or if continued sluggishness will necessitate further retrenchment in the stocks.
A group of analysts who follow the industry’s publicly traded companies said the second-half decline in share prices last year correlated well with trucking’s actual earnings returns. But current valuations make the most sense, they said, if an investor assumes gross domestic product soon will take off from the 0.6%-a-year growth the Commerce Department said was the economy’s first-quarter performance.
Overall economic growth also could determine whether two privately held trucking companies might soon launch initial public offerings, thereby balancing a trend toward the use of private equity, and if Wall Street has been wise in boosting the stock price of one of the nation’s largest truckload carriers.
“This year is still not good for freight, but the Street is looking through those problems of sluggish freight,” said David Ross of Stifel, Nicolaus & Co. in Baltimore.
“Corporate earnings and balance sheets are looking pretty good, so people are thinking things will get better in the second half,” he said in summarizing the argument of a Wall Street “bull,” or optimist.
On June 15, Ross’ colleague at Stifel, John Larkin, said the investment firm was lowering its estimates of earnings per share for 13 motor carriers for the quarter ending June 30. Larkin said he has not seen signs that second-quarter demand for freight-hauling services has improved notably over the first three months of this year.
Jason Seidl of Credit Suisse, New York, offered the opposing “bear” point of view, that stock prices this year have “gone up, based on the anticipation of a second-half turnaround, but operationally, the industry continues to be difficult. I hear more negatives than positives operationally.”
Seidl also said, “There might not be an improvement in the back half of this year. If 0.6% GDP growth continues, there will be problems. These stocks are proving out now that they are indeed cyclical.”
Trucking and other transportation stocks have had good runs for at least the past three years, outperforming the broader market, as represented by the Standard & Poor’s 500. The Dow Jones Transportation Average increased by 78% for the three years ended June 1, an S&P trucking index grew by 59% over the same time and the S&P 500 moved up 37%.
However, for the most recent 12 months, the broader market has returned to dominance, with the S&P 500 and the Dow Jones Industrial Average setting new records in early June.
For just the year ended June 1, the rates of appreciation among the indexes were 19.3% for the S&P 500, 11.8% for Dow Transportation and 5.8% for S&P trucking.
Less-than-truckload carrier Con-way Inc. and truckload carrier Knight Transportation are cases in point as carriers with well-respected management that still have seen a lot of share-price volatility. Con-way shares traded for nearly $60 each in late June last year, but by the end of the year, they had dropped more than 25% to $43, and in early June, they were back to nearly $57.
Knight shares sold for about $21 a share in early July and dropped nearly 25% to $16 in early September. The stock topped $20 in April and opened in June around $19.
“Expectations of the economy slowed at the midpoint of last year due to, first, the housing industry and then the downturn among U.S. auto manufacturers. That created an excess of capacity in trucking and very tough year-over-year comparisons,” said Art Hatfield of Morgan Keegan & Co., Memphis, Tenn.
“So far, we’ve seen the inverse this year. Going into 2007, companies cut their earnings estimates, so they are now much more reasonable. Now, they’re not missing their numbers by as much. . . . Shares were repriced appropriately from the ways things fell out,” Hatfield said.
However, the company that has generated greater buzz among stock pickers is the one with the atypical performance: J.B. Hunt Transport Services.
Hunt shares sold for almost $26 each in early July and then dropped to about $19 around Labor Day. Since then, though, the stock has appreciated by more than 50% to more than $29 a share in early June. That increase led Donald Broughton of A.G. Edwards & Sons in St. Louis to place a “sell” rating on the company.
“It’s a great company with great management, but its debt-to-capital ratio has risen to 40% from almost nothing two years ago because of its recent buy-back of shares. And I don’t see how they can continue to add assets [mainly intermodal containers] while asset-utilization rates fall and still expect margins to continue.
“It’s a damn good trucking company, but risk has increased and this is not a complicated business. It’s all about asset utilization,” Broughton said.
Jon Langenfeld of Robert W. Baird & Co. in Milwaukee said investors have lined up behind Hunt because “almost 50% of its profits come from intermodal. It’s not a pure trucking company.”
Kirk Thompson, Hunt’s chief executive officer, has repeatedly made the point at investment conferences such as Bear, Stearns & Co. and BB&T Capital Markets that his company is much more than a traditional truckload carrier. While the company’s roots are in truckload operations, it also offers services in truck-rail intermodal, dedicated contract carriage and freight brokerage.
During the first quarter of this year, intermodal and dedicated each contributed more to operating income than did traditional truckload. Thompson has told investors this is why his company merits a higher price-earnings multiple than a traditional truckload carrier.
“Give them credit for the best-operating model in truckload land. It’s the best intermodal franchise out there,” said Seidl of Credit Suisse.
“They’re clearly taking market share when others are struggling. That gives them a definite cushion and a premium valuation,” he said.
Bob Costello, chief economist for American Trucking Associations, consistently declines requests to talk about stock market events, but he offered a cautious assessment on trucking’s fit within the U.S. economy.
In his ATA Truck Tonnage report on business in April, he said the economy has been in a state of transition and that the market for freight hauling has exhibited “choppiness” (6-4, p. 1). He said this trend could end up as a midcycle pause for business.
“Unfortunately for trucking, this pause has hit important freight sectors,” such as housing and automotive, he said in an interview.
Costello said the consensus estimate for second-half growth is 2%, down from earlier estimates of about 2.5%.
“The second half of this year should be better — not great but better,” he said.
He said he thinks the tangible goods-based economy, the base of freight shipping, probably will grow by less than overall GDP this year but probably should expand at a faster rate than GDP in 2008.
Another part of the trucking-stock market puzzle is the number of motor carriers traded on stock exchanges. Several have either left exchanges or announced plans to do so, including Swift Transportation Co., Transport Corp. of America, Jevic Transportation, Allied Holdings and Smithway Motor Xpress Corp.
In contrast, only two carriers recently have said they might go public: Western Express in November 2005 and Panther Expedited Services in July 2006.
While not directing his remarks to the specifics of those carriers, Baird’s Langenfeld said, in general, “This is a difficult environment now and not supportive of [an initial public offering] sale; 2005 was an ideal time, but for right now, it’s highly unlikely in asset-based trucking.”
Morgan Keegan’s Hatfield offered a variation:
“It’s better today than it was six months ago. You should be looking to do an IPO when there’s more potential to expand rather than slow. You do it when a growth period is expected,” he said.
One of the reasons companies leave the exchanges is that they can get financial backing through private equity.
“It’s been a strange year,” Seidl said, “in that almost everyone I follow is up year-to-date. With $2 trillion in private equity available worldwide, that money can’t stand still.
“If you’ve performed well operationally, your stock gets a bounce, and if you haven’t, it still does because people think you might be a candidate for a takeout by private equity.”
However, he said that is not necessarily a one-way transformation.
“This, too, shall pass because most exit strategies for private equity feature going public at some point.”