Susquehanna analyst Bascome Majors thinks that while contract rates will be under downward pressure for the rest of the year, spot prices may have started to inflect upward.
In the past week or so, Wall Street banks have been preparing for second quarter earnings results from transportation and logistics companies and updating their estimates. Morgan Stanley and Deutsche Bank have revised their earnings-per-share (EPS) estimates downward already and picked their favorite names in a generally weak transportation environment.
Morgan Stanley thinks that after Q2 results come in and companies lower their full-year earnings guidance, truckload stocks will be cheap enough to re-enter. Morgan Stanley’s Ravi Shanker likes Knight-Swift (NYSE: KNX), Schneider National (NYSE: SNDR), U.S. Xpress (NASDAQ: USX), and Werner Enterprise (NASDAQ: WERN) after projected earnings come down and reset price-to-earnings ratios.
Deutsche Bank shared the pessimistic outlook for transportation demand, citing weak manufacturing growth, weaker imports, and elevated industry levels. Still, Deutsche Bank analyst Amit Mehrotra picked some idiosyncratic stories — Knight-Swift may be back in the hunt for acquisitions after successfully integrating Swift and XPO (NYSE: XPO) and is “staggeringly” under-valued. And of course, the Class 1 rails are expected to continue printing cash regardless of soft volumes due to the further implementation of Precision Scheduled Railroading, especially Union Pacific (NYSE: UNP).
This morning Susquehanna analyst Bascome Majors chimed in with his own take on the Q2 outlook for transports. Majors agrees that the second quarter was weaker than expected for transportation because the traditional summer volume surge never fully materialized and overcapacity continues to hold down trucking rates. Still, he thinks that a recent spot rate inflection could bode well for companies whose revenue is tied to the spot market.
“While we remain cautious as consensus falls, exiting earnings season we see potential to add risk in names exposed to the shorter end of the truckload rate curve (e.g. spot-levered LSTR, ECHO),” Majors wrote in an investor note the morning of July 12.
Spot rates are more volatile than contract prices and pull them up and down on at least a three month lag. The national average truckload spot rate (DATVF.VNU) began deteriorating in the third quarter of 2018, well before publicly-traded carriers began guiding down expectations for contract prices; in fact, carriers were still telling investors they expected contract rate increases as late as the second quarter of 2019. Majors sees downward pressure on contract rates through the rest of the year as shippers readjust to the wide spread between contract and spot prices and re-align their spend to market conditions. At the same time, spot markets got a healthy June bounce that, while still 23 percent down year-over-year, signaled that capacity is not loose as to become completely unresponsive to seasonality.
“Turning to a few checks, conversations with brokers were supportive of the rate build seen at the end of June and into early July with uncertainty as to whether increases are the result of capacity leaving a challenged spot environment or destocking of elevated inventories finally starting to play out,” Majors wrote.
Capacity continues to bleed out of the market, and with the abrupt shutdown of LME (Lakeville Motor Express) on July 11, this year has already witnessed five major trucking carrier exits. FreightWaves is monitoring the number of carrier exits (EXIT.USA) on a quarterly basis by looking at write-downs of bad debt by lenders to trucking companies. The first quarter of 2019 saw a multi-year high in trucking exits, and that number could surge even higher when data for the second quarter are released.
To be clear, Susquehanna cut earnings estimates for Echo Global Logistics (NASDAQ: ECHO) and Landstar System (NASDAQ: LSTR) by 9 percent and 3 percent, respectively. It’s just that Majors believes once the market fully digests second quarter results, those companies will start inflecting upward. In my view, this is a variation of Amit Mehrotra’s “second-derivative trade” thesis: investors will re-enter not when year-over-year comparisons are positive, because that’s too late, but when they’ve stopped getting worse and start improving.
Majors sees some reason for encouragement in spot market data.
“Seasonally, dry van spot rates have outperformed 2014-2016 average historic seasonality over the past six weeks with rates up 10.4% six-week sequentially (460bps better than the ’14-’16 average, boosted by stronger than typical road check impact) as rates steadily climbed higher to close out the quarter, in what we’d characterize as a late but welcome seasonal increase that’s typically seen earlier in 2Q,” Majors wrote.
The Susquehanna note also read through data in other modes for clues to trucking performance. CSX’s (NASDAQ: CSX) intermodal volumes have fallen the most of any Class 1 rail in the second quarter, about twice as much as a percentage of total carloadings (-10.2 percent year-over-year) as the other rails, but that contraction is attributed to internal adjustments — CSX exiting low-margin, low-volume lanes — as much as the overall business environment. CSX’s primary intermodal partner is Schneider National. J.B. Hunt’s (NASDAQ: JBHT) partners BNSF and Norfolk Southern (NYSE: NSC) saw intermodal volumes fall 5.2 percent and 2 percent year-over-year, respectively.
Majors models 5 percent growth in intermodal volumes for J.B. Hunt in 2020.
“So while we’re encouraged by some capitulating estimate cuts on trucking-related names as pricing outlooks become more realistic, we’d like to see firmer signs of demand stabilization before shifting to a broader ‘risk-on’ approach, particularly toward asset-based models,” Majors concluded.