Goldman Sachs equities analysts believe that weakness in the industrial sector of the U.S. economy will persist through the first quarter of 2020 before positively inflecting in the second quarter, leading them to cut earnings estimates for the transportation companies in their coverage universe.
Analyst Jordan Alliger wrote last week in an investor note that “it is just tough to ignore ongoing softness in weekly rail carloads (economically sensitive carloads -3.3% in 3Q – worsening from +0.9% in 2Q), taken together with two consecutive months of ISM below 50.”
Alliger’s team cut 2020 earnings per share (EPS) estimates across a broad swath of transports – CSX (NASDAQ: CSX), Norfolk Southern (NYSE: NSC), Union Pacific (NYSE: UNP), Canadian National (TSX: CNR.TO), Canadian Pacific (TSX: CP.TO), FedEx (NYSE: FDX), XPO Logistics (NYSE: XPO), J.B. Hunt (NASDAQ: JBHT), C.H. Robinson (NASDAQ: CHRW) and Expeditors International (NASDAQ: EXPD).
Prior to the note, Goldman’s models assumed some positive freight growth in the first half of 2020. The estimate cuts reflect Goldman’s conviction that the current slowdown will follow the pattern of previous industrial recessions, which typically last five to seven months, as measured by ISM data; that means that industrial activity may not begin improving until sometime in the second quarter of 2020.
Goldman warned that the current estimate cuts only signify direction, and may not be the last cuts, depending on what companies can do to reduce costs and whether volumes do in fact snap back.
“Should we see the consumer slow sharply, or peak retail season disappoint, it would call into question our newly revised down EPS estimates for 2020 – in other words the potential for much deeper EPS cuts would arise,” Alliger wrote.
Goldman cut 2020 EPS by 2-4% across the railroad sector, although Norfolk Southern, on Goldman’s conviction list, and Union Pacific still maintained their ‘Buy’ ratings. The Canadian rails and CSX have mostly completed the cost-reduction measures in Precision Scheduled Railroading and are more vulnerable to weaker volumes. Canadian National was hit by lower crude-by-rail volumes, a delayed grain harvest, a weak lumber outlook, and a reduction in exported American coal. Canadian Pacific was affected by weak potash and the delayed grain harvest, while CSX is experiencing “near-term weakness in intermodal and coal.”
J.B. Hunt, Alliger wrote, is set up to benefit from a tightening of truck capacity – due to new truck orders running below replacement levels – and efficiency improvements in the railroads in the second half of the year, although earnings should be softer in the first half of the year. Goldman left Hunt’s 12-month price target unchanged at $116, representing just a 5.9% upside from the company’s current share price of $109.52.
Coming off a recent UPS management visit, Goldman left estimates and its ‘Buy’ rating for the parcel integrator unchanged; the bank’s price target for UPS is still $136, almost exactly where the stock opened on Monday, October 14.
“We still expect UPS to benefit meaningfully for at least the next three quarters from greater Next Day Air volume tied to big box retailer penetration, as well as incremental Amazon business related to FDX no longer servicing this customer,” Alliger wrote. “This outsized domestic volume growth should help push down cost per shipment and improve operating margin.”
FedEx stock has been beat up due to a string of earnings misses followed by lowered guidance; Goldman’s price target at $178 represents a 21% premium to the current price of the stock. Alliger mentioned a range of factors from continued integration expense around the TNT acquisition to general industrial weakness could delay margin improvement until fiscal year 2021, but that FedEx’s high operating leverage is well-positioned to make the most of any recovery in volumes.
The non-asset and asset-light intermediaries in Goldman’s coverage – CHRW, XPO and EXPD – were all dinged on expectations for soft volumes, which will negatively offset margin expansion on lower capacity costs (whether truckload, air or container). Expeditors was the only transport tagged with a ‘Sell’ rating.
“We make only slight adjustments to EXPD earnings outlook as the non-asset intensive model mitigates the ongoing ocean and air forwarding volumes,” Alliger wrote. “That said, the shares still trade at a logistics group premium at a time when China-U.S. trade is a major concern.”
Expeditors’ price to earnings ratio was about 19x, but still below its five-year average of 21.1x. Although the stock is currently trading at $74, Goldman lowered its price target to $68 from $70.
“Taken together (an industrial, not consumer slowdown, easy YOY comps in 2020, and multiple compression tied to expected EPS re-set), we tie in share price performance during prior “freight recessions” and note: share prices tend to react favorably around the mid/back half of a contraction,” Alliger concluded.