On a Wednesday conference call with the firm’s clients, UBS (NYSE: UBS) freight transportation analyst Tom Wadewitz said he expects a “falloff” in rail and truck volumes in April and May. He said the coronavirus-related volume surge in recent weeks has created a consumer inventory buildup of at-home essentials like groceries and household supplies.
He noted that e-commerce shipments may be more resilient moving forward, but cautioned investors that the growth in business-to-consumer volumes is likely skewed to lower-margin goods.
Wadewitz believes that recent spot market metrics and data could be indicating that the market is setting up for something worse than the industrial recession in 2015 and 2016. However, he believes that freight markets still have a distance to go before experiencing the degradation seen during the global financial crisis of 2008-2009.
In that period, trucking companies and Class I railroads reported 15% to 30% declines in earnings before interest, taxes, depreciation and amortization (EBITDA), with trucking companies cutting their capital expenditures (capex) by as much as half. While Wadewitz isn’t baking in an earnings decline similar to that of 2008-2009, his current earnings estimates are already below consensus forecasts.
“Our current 2020 EPS forecasts for the transports are 8% to 12% below consensus for most names, but we are assuming a meaningfully more moderate downturn versus 2008-2009 which could be optimistic,” Wadewitz said.
Railroads to struggle with industrial, international exposure
He sees the railroads as having material downside risk as the group has significant international and industrial exposure. Commodities that are likely to see the most pressure are international, trade-related intermodal, automotive, crude oil, frac sand, petroleum/natural gas and metals.
This was the same justification used in his rating downgrade of Kansas City Southern (NYSE: KSU) to “neutral” earlier in the day. Wadewitz believes that the railroad has more exposure to the “at-risk” commodities, or those heavily tied to the industrial complex, than any other Class I railroad. He believes as much as 47% of Kansas City Southern’s revenue is exposed to these markets and could be meaningfully impacted by a downturn.
Brokers and TLs more defensive in this downturn
Wadewitz sees the rails as having a greater risk for volume weakness than trucking, which is more weighted to the consumer, notably food and beverage. Additionally, he sees the more variable cost structure of the TLs as favorable to the higher fixed-cost network of the less-than-truckload (LTL) carriers. He called out “buy”-rated Knight-Swift Transportation Holdings Inc. (NYSE: KNX) and Schneider National (NYSE: SNDR) as the truckload (TL) companies that may endure the current weakness better than others. He believes the potential falloff in freight will force more TL operators to cut capacity or exit the market, providing an eventual narrowing in the supply-demand gap, allowing rates to firm.
However, he said there is headline risk to these names in the near term, especially if spot market metrics roll over, but noted that expectations for trucking have been muted for 2020. Wadewitz said the year will likely produce trough-level earnings results for the sector.
Currently, FreightWaves’ Outbound Tender Volume Index has begun to recede after a month of acceleration. While in decline for more than a week now, the volume index is still higher on a year-over-year comparison.
2020 was expected to be a year of significant contraction in truck capacity. After record truck additions during and after the 2018 peak, volumes have been much lower than required to support the industry’s new capacity glut. Lower rates, cost inflation across the carrier P&L and new regulation have forced many carriers to exit the market. These trends remain prevalent and may accelerate if the industry is indeed about to go off the volume cliff. However, the expected midyear market tightening and rate bump appear to have been delayed.
Pressure on C.H. Robinson easing?
Wadewitz views the brokers and TLs as more defensive than the other sectors he follows.
Using that rationale, Wadewitz upgraded C.H. Robinson Worldwide (NASDAQ: CHRW) to “buy,” describing the freight broker as the most defensive name in his coverage universe. He said margin pressure will be prevalent in the first quarter as the truck market tightened significantly in March, forcing the company to pay up for TL capacity to move shipments already under contract.
However, he noted easier year-over-year comparisons for the company in the second quarter and back half of the year. Additionally, there will be a looser capacity environment in the second quarter if volumes decline as expected, which should result in improving gross margins. He believes that the company will have a rough first quarter, but that the commentary from management could be more constructive relative to other companies as C.H. Robinson enters a period of easier comps.
Conversely, he noted that forward-looking commentary provided by the TLs could be less inspiring. He believes the carriers will likely report results indicative of a recent surge, but management teams are likely to be more subdued on their outlooks given the expected volume headwinds in April and May.