The less-than-truckload carriers got another bull in their camp on Tuesday when UBS (NYSE: UBS) freight transportation analyst Tom Wadewitz initiated coverage on the sector with a favorable outlook.
In a report to clients, Wadewitz launched coverage of Old Dominion Freight Line (NASDAQ: ODFL) and XPO Logistics (NYSE: XPO) with “buy” ratings and Saia (NASDAQ: SAIA) with a “neutral” rating. He pointed to rebounding industrial activity as supportive of his forecast for tonnage growth of 5% in 2021 along with price increases of 4% to 5%.
The combination “should translate to strong margin expansion and growth.” He expects earnings to increase 30% for Old Dominion and Saia, with earnings before interest, taxes, depreciation and amortization up by a similar amount at XPO. His earnings per share estimates are approximately 5% higher than consensus in 2021 and 2022 for Old Dominion and Saia. The Old Dominion forecast for next year is 8% above the Street. The XPO EBITDA outlook is only slightly ahead of current consensus expectations.
“We believe ODFL’s industry-leading margin, strong growth and resilient EPS in prior downturns support strong valuation and attractive upside while upside for XPO is driven by cyclical leverage and potential lift from its plan to simplify (logistics spin-off),” Wadewitz added.
LTL tonnage outlook improving
Wadewitz pointed to normal cyclical patterns to derive his 5% tonnage growth forecast. He noted that LTL tonnage declines were more significant in the recent downturn, down 4% in 2019 and 3% lower last year, than in some of the prior cycles. He believes recent year-over-year tonnage improvements along with improving rail volumes are evidence of “rising momentum in the industrial economy.” His growth forecast calls for tonnage to increase 3.5% in 2022.
Manufacturing and industrial activity, which can account for up to 85% of LTL tonnage for some carriers, continues to improve, according to recent data points.
The Manufacturing Purchasing Managers’ Index (PMI) increased 3.2 percentage points to 60.7% in December, the seventh straight month the index has been in expansion territory. An index reading above 50% indicates growth in the U.S. manufacturing sector. LTL demand has a high correlation to the PMI data, with volumes lagging the index by roughly three months.
Additionally, the new orders subindex climbed to 67.9%, the production component rose to 64.8% and customers’ inventories remained “too low” at 37.9%.
Friday’s Federal Reserve data showed U.S. industrial production was up 1.6% in December with manufacturing seeing a 0.9% increase. Capacity utilization for the sector improved 1.1 percentage points to 74.5% in the month. Total industrial production was still 3.6% lower year-over-year in December and 3.3% below February’s pre-pandemic level but the data set is moving in the right direction again.
Wadewitz’ LTL report also noted the recent positive year-over-year inflection in shipments data from Cass Information Systems (NASDAQ: CASS), which has a high historical correlation with LTL tonnage. Further, he called out work done by the firm’s electrical equipment and multi-industry analyst, which highlighted increased capital expenditure expectations across several industries as supportive of the LTL growth theme.
Wadewitz sees an extended runway for terminal expansion and volume growth at Saia and Old Dominion, which have been very active adding terminals in recent years. The firm’s geospatial analysis showed that the industry’s largest carrier, FedEx (NYSE: FDX), operates a terminal network covering 89% of U.S. business addresses within a 60-minute drive time. That is 4 to 6 percentage points higher than the industry’s other large carriers and 14 percentage points higher than Saia’s terminal coverage.
The thought is that Saia and Old Dominion still have geographic coverage opportunities in front of them.
LTL pricing to continue healthy run
The last couple of freight downturns have shown that pricing in the LTL industry remains stable, allowing carrier margins and valuation multiples to expand, according to Wadewitz. LTL pricing has been in a positive range of 2% to 5% over the last decade as the less-fragmented, high barriers to entry industry remains committed to yield improvement.
The report showed how improvements in truckload spot market rates lead LTL pricing by several quarters. TL spot rates have been on a historic run since bottoming in April. The freight spillover effect, TL freight moving to LTL carriers as available spot TL capacity erodes, has also contributed to a tightening in the LTL market.
“We expect LTL pricing in the mid-single digits in 2021 and 2022 against a stronger freight backdrop,” Wadewitz stated.
Valuation multiples not out of line when compared to growthy industrials
The report showed that valuation multiples are high for Saia and Old Dominion at roughly 29 times EPS estimates for 2021, compared to historical EPS valuations in the high teens (Saia) and low 20s (Old Dominion). But Wadewitz believes the levels are warranted and in-line with other “strong growth industrials,” or other companies with compounded annual growth rates in the high single digits for revenue and mid-teens for EPS.
He also sees a couple of multiple points in upside to XPO’s enterprise value-to-EBITDA ratio, an alternative to price-to-earnings valuation, which minimizes the negative impact high-debt burdens and elevated nonoperating expenses place on the valuations of growing companies.
“We expect investors to respond well to the resulting simplification of XPO’s business mix. Following the spinout of its logistics/warehouse business, XPO will have a favorable mix of a large business in the attractive LTL market and a brokerage business that has the scale to compete and win in brokerage,” Wadewitz said.
The LTL earnings season begins Feb. 2 when ArcBest (NASDAQ: ARCB) reports fourth-quarter results. Stay tuned to FreightWaves for coverage of LTL earnings and continuing coverage of all other modes of transportation.
