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Jubak's Journal
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| | Jubak's Journal
Transport winners will keep on trucking
The freight-movers -- railroads, shippers and big-rig truck makers -- have turned a shortage of space into outsized gains, and it'll be years before capacity catches up.
By Jim Jubak
Nothing succeeds like success. Investors would do well to keep that sage advice in mind in the new year.
And for good reason. Theres a sizable body of research that shows that momentum doesnt disappear with the turn of a calendar page. Since 1991, the strategy of sticking with the previous years 10 best-performing industries for another year has produced a compounded annual return of 18.4%, according to Sam Stovall, chief investment strategist for Standard & Poors. That clobbers the annual return of 9.7% on the Standard & Poors 500 ($INX) stock index.
The logic behind this outperformance is pretty straightforward. If the reasons for an industrys success are good enough to push it to the top in the first place, its likely that those fundamentals have relatively long lives. Then theres human nature. Rising prices draw more buyers to a stock. Thats how momentum works.
Of course, the music does stop at some point, often very abruptly, resulting in what can be a very damaging race to sell. That's why I like industries where strong or improving fundamentals support the price momentum.
Where demand still chases supply
My favorite sector for a buy-the-winners strategy in 2005 has to be transportation. The fundamental mismatch between supply and demand that drove revenue and earnings at most of the companies in this sector is still intact for 2005 and beyond.
Looking at the names of the 20 stocks that make up the Dow Jones Transportation Average ($TRAN), youll be amazed that this index went up at all. A good 25% of the list belongs to airlines, and we all know what a great year that industry had in 2004. Four of the five on the list turned in substantial losses.
| The Dow transports | | Company | Industry | 2004 gain | Company | Industry | 2004 gain | | Alexander & Baldwin (ALEX, news, msgs) | Marine trans. | 25.7% | GATX Corp. (GMT, news, msgs) | Business support services | 5.7% | | AMR (AMR, news, msgs) | Airlines | -15.4% | J.B. Hunt Transport Services (JBHT, news, msgs) | Trucking | 66.1% | | Burlington Northern Santa Fe (BNI, news, msgs) | Railroads | 46.2% | Norfolk Southern (NSC, news, msgs) | Railroads | 53.0% | | C.H. Robinson World (CHRW, news, msgs) | Trucking | 46.5% | Northwest Airlines (NWAC, news, msgs) | Airlines | -13.5% | | CNF Inc. (CNF, news, msgs) | Trucking | 47.8% | Ryder System (R, news, msgs) | Trans. services | 39.9% | | Continental Airlines (CAL, news, msgs) | Airlines | -16.8% | Southwest Airlines (LUV, news, msgs) | Airlines | 0.9% | | CSX Corp. (CSX, news, msgs) | Railroads | 11.5% | Union Pacific (UNP, news, msgs) | Railroads | -3.2% | | Delta Air (DAL, news, msgs) | Airlines | -36.7% | United Parcel Service (UPS, news, msgs) | Delivery services | 14.6% | | Expeditors Internat'l (EXPD, news, msgs) | Delivery services | 48.4% | USF Corp. (USFC, news, msgs) | Trucking | 11.0% | | FedEx (FDX, news, msgs) | Delivery services | 45.9% | Yellow Roadway (YELL, news, msgs) | Trucking | 54.0% |
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Fortunately for the performance of the index, the Dow Jones Transportation Average is weighted by stock price so that the damage done by drops in low-priced shares like Delta Air Lines (DAL, news, msgs) at $6.62 a share or Northwest Airlines (NWAC, news, msgs) at $8.60 is easily balanced by gains in high-priced shares such as Burlington Northern Santa Fe (BNI, news, msgs) up 48% and recently trading at $45.11, or in FedEx (FDX, news, msgs), up 46% and trading at $94.91.
Even with that caveat, you can see that the other 15 stocks in this index had to zoom to produce a 26.3% gain for the year. Nine of the stocks in the index, in fact showed gains of 40% or better in 2004.
Among the winners, look for also-rans
But I'm most interested in the returns of the five stocks that returned less than 20% for 2004. Some of these stocks, such as Union Pacific (UNP, news, msgs) and CSX Corp. (CSX, news, msgs), represent companies that had big, big troubles in 2004. Union Pacific couldn't keep its trains running on time, and still the stock declined just 1% for 2004. CSX lagged all of its railroad peers in almost every important measure of profitability: In S&Ps words, a below-peer-average performance in terms of revenues, margins and operational performance. And yet CSX shares gained 13% in 2004.
The fundamental trend delivering 40% gains for solid companies and double-digit gains for mediocre ones is the same factor that hurt airline stocks so badly in 2004: capacity. The airlines suffer from overcapacity that has forced them to slash prices below break-even just to keep their planes relatively full. The rest of the transportation sector is thriving because of undercapacity: There just arent enough trucks, box cars, and ships --and trained workers -- to keep up with the demands from a hot global economy to move raw materials, subassemblies and finished goods from hither to yon.
You can see that undercapacity reflected in statistics all across the transportation sector. For example, the average truck now coming to the used truck market has about 500,000 miles on it, up from 300,000 miles in 2003. Drivers are running their equipment a lot longer and a lot harder in an effort to keep up with demand.
Both Burlington Northern and Union Pacific are rushing to complete a second transcontinental track that would run next to their current cross-country lines. When finished, this double-tracking will make it possible for the railroads to run multiple trains at different speeds and going in different directions without the constant need to shunt trains to sidings to wait until other trains pass. That tight-fisted railroads are spending to lay this track testifies to their projections for healthy growth in future traffic -- and the earliest either railroad will finish double-tracking will be 2008.
The players for 2005 and beyond
That shortage of capacity amidst continued growth in demand convinces me that transportation is a good place to be again next year. The momentum in this sector should mean that these stocks wont spend 2005 spinning their wheels, either, while they wait for investors to discover them.
Here are my five picks in the sector.
The Greenbrier Cos. (GBX, news, msgs) is riding the coattails of the railroads in their current prosperity. The company makes freight cars and double-stack intermodal (truck to rail to truck) equipment and performs maintenance and repairs on more than 100,000 railcars as well. The companys leasing division owns about 11,000 cars. This pick is a play on the aging of the equipment in the railroad industry. For example, at the end of 2003, the average age (from manufacture or re-manufacture) of a freight car in Burlington Northerns fleet was 16 years. Theres a lot of backlog here, folks. Wall Street projects earnings growth of 35% for Greenbrier in the fiscal year that ends in August 2005 and 26% growth for fiscal 2006.
UTI Worldwide (UTIW, news, msgs), like Dow Transportation Average member Expeditors International (EXPD, news, msgs), is in the business of finding the cheapest and fastest way for customers goods to travel. Companies like UTI Worldwide profit from the squeeze on capacity because it raises the price that customers will pay for their expertise and drives more companies to switch to outside logistics experts. As a so-called asset-less logistics company, UTI doesnt have its own drivers or trucks, so it is removed from the turmoil that is now breaking out among drivers at freight companies such as FedEx (FDX, news, msgs), where some drivers now paid by the company as independent contractors have asked the Internal Revenue Service to investigate. UTI Worldwide seems to be well positioned for trends in the global economy, too. In the most recent quarter, the Asia-Pacific region was the biggest source of gross revenue for the company.
Paccar (PCAR, news, msgs), like Greenbrier, is another company in the business of supplying equipment to the transportation boom. This is, in my opinion, the best managed of the truck manufacturers, and its still cheap at just 16.4 times trailing 12-month earnings and 14.6 times projected earnings. The shares are so cheap because Paccar operates in a cyclical market, and analysts are looking for truck sales to drop from recent peaks. But I think that overlooks the size of the backlog in demand for heavy trucks. Trucking companies have been slow to add new trucks in the current boom because theyve faced a shortage of drivers. As that gradually eases, I expect truck sales to show continued strength.
Burlington Northern Santa Fe (BNI, news, msgs) hasnt escaped all the problems that have bedeviled Union Pacific this year: higher freight volumes have led to delays on Burlington Northerns system as well. But the railroad has been able to keep most of its customers happy enough so that it has been able to raise freight prices for the first time in years. Wall Street is projecting a decline in earnings growth to 18.5% in 2005 from 30% in 2004. Thats certainly not terrible news for a stock trading at just 16.7 times projected 2004 earnings per share, but I think projections are low given the strength in coal traffic and continued solid growth in the U.S. and Chinese economies. Over the long haul, what excites me about Burlington Northern is the companys lead in double-tracking its major transcontinental route. The job is now about 90% done.
In my next column, Im going to take a look at another big sector, the financials. The sector as a whole just about matched the S&P 500 in 2004, but that solid return masks some really disappointing performance in industries such as mortgage and consumer finance. Is there hope for a recovery in 2005 if the Federal Reserve continues to raise interest rates?
Changes to Jubak's Picks
Buy Burlington Northern Santa Fe
Railroads eat capital, first when you build them and then every year when you have to spend cash to maintain all those tracks and rolling stock. Count on spending 15% to 20% of revenue on maintenance. During slow times, that just kills railroad profits. The cash has to be spent whether or not the revenue is coming in, and there are all the interest payments that have to be made on the debt used to raise capital. For example, Burlington Northern Santa Fe finished the September 2004 quarter with $6.4 billion in debt. In good times, however, the capital-intensive nature of the railroad business acts as a huge barrier to entry. You wont find anybody starting up a new transcontinental railroad any time soon no matter how good the rail business gets. That gives the existing lines huge power to raise prices, especially on the long-distance routes that carry trucks piggyback rather than competing with them. And since so many of a railroads costs are fixed or close to fixed -- the cost of maintaining a mile of track only increases very slowly with increasing freight volumes -- earnings growth can explode when volumes soar. So in 2002, earnings per share grew just 5.8% from the previous year, and in 2003 just 4.5%. But in 2004 theyre projected to climb 30% and then record an additional 18% growth in 2005. I think the estimates for 2005 will turn out to be low, and selling at 16.7 times projected 2004 earnings, I think Burlington Northern is still cheap. As of Jan. 10, Im adding the stock to Jubaks Picks with a December 2005 target price of $53 a share.
New developments on past columns
3 strategies to beat the market in 2005
In my Jan. 4, 2005, preview of the 2005 investing year, I said that the Wall Street consensus for 3% to 4% economic growth in the United States in 2005 assumes that the steps that China is taking to slow its economy wont send that economy into a tailspin. So far, so good. The newly released targets for money supply growth in 2005 show a continuation of 2004s plan and no signs of an intention to turn the screws tighter on growth. On Jan. 4, Chinas central bank announced a target of 15% growth for the M1 and M2 measures of money supply. Thats in line with the 14.5% actual growth in these measures in 2004 and only slightly below the 17% target the bank set last January. These targets also suggest that the central bank sees no reason to raise Chinese interest rates again.
Editor's Note: A new Jubaks Journal is posted every Tuesday and Friday.
E-mail Jim Jubak at jjmail@microsoft.com.
At the time of publication, Jim Jubak did not own or control shares in any of the equities mentioned in this column. He does not own short positions in any stock mentioned in this column.
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