UBS (NYSE: UBS) freight transportation analyst Tom Wadewitz sees a favorable freight setup in the first half of 2021. His expectations for the year were laid out on a conference call with clients Thursday reviewing his outlook report published earlier in the day.
The call is for “a combination of rising growth in freight activity plus strong pricing to support strong EPS performance and upside for the transport group in 2021.” He believes the stocks with the most upside are FedEx (NYSE: FDX) and UPS (NYSE: UPS), with modest upside present in the railroads, truckload carriers and asset-light providers.
Domestic package market to stay tight
The bullish call on FedEx and UPS centers around the expectation for domestic package volumes to remain elevated. The UBS internet equity research team is forecasting e-commerce sales to increase 16% in 2021, following a 34% jump in 2020. Additionally, network and capacity constraints at many parcel providers leads Wadewitz to believe FedEx and UPS can capture “strong pricing gains” this year.
He noted that the pricing cycle is still in the early stages and when combined with productivity initiatives, margin improvement potential and the recent pullback in the stocks, FDX down 17% and UPS off 9% in the last month, the parcel story is compelling.
He cautioned that sortation and delivery facility build-outs at Amazon (NASDQ: AMZN) present a risk to UPS, especially if it is a signal that the retail and logistics giant plans to insource package delivery at a faster pace than planned. Amazon is expected to further its real estate expansion at a sizable pace again this year but not likely at the robust clip seen in 2020.
Investors shift focus to industrial economy
Wadewitz said investors have already shifted their focus to transportation companies that have more exposure to the industrial economy, like the railroads, shying away from the truckload carriers. He still expects consumer-related freight flows to “stay strong.”
The Manufacturing Purchasing Managers’ Index (PMI) jumped to 60.7% in December, up 3.2 percentage points from November and the seventh straight month of expansion. A reading above 50% implies expansion in the U.S. manufacturing sector.
The new orders subindex climbed 2.8 percentage points to 67.9% and the production component moved 4 points higher to 64.8%. Additionally, customers’ inventories remained “too low” at 37.9%, which is “considered a positive for future production,” according to the December PMI report.
Wadewitz believes an improving industrial patch will allow rail volumes to “strengthen and peak against easy comps in 2Q21.” Additionally, the revenue and margin profiles of the railroads will improve if industrial carloads catch up with consumer-driven intermodal loads. He’s forecasting 5.5% industrial volume growth in 2021 on a year-over-year basis, which assumes a 3.5% increase in U.S. industrial production.
Canadian Pacific (NYSE: CP) is his top rail pick as he believes it has the best revenue growth story – grain, potash and intermodal. He also likes the recent contract wins the railroad has inked, including an agreement with Maersk (OTC US: AMKBY) to build a transload and distribution facility at CP’s intermodal facility in Vancouver, British Columbia, which comes online this year.
He said railroad valuations are high when compared to their historical averages but are more attractive when compared to other industrials.
Truckload stocks have fallen out of favor; C.H. Robinson gets interesting
Wadewitz said the relative valuation discount for the TLs “remains significant” as the stocks have retreated from September highs even as the spot market has remained very tight. However, he noted that acceleration in TL valuations will be difficult as capacity loosens later in the year.
The call is for TL freight to remain elevated throughout the first half of the year as inventory restocking demand remains healthy given surging sales at the retailers, which have outpaced inventory builds. Further, second-quarter comparisons are extremely easy given the freight falloff experienced during the early months of COVID. UBS’ economics team is forecasting goods spending to increase 8% to 11% through the first half of 2021.
More loads are expected to be moved under contract as the year advances with inventory restocking cooling and consumers shifting their spending patterns to services versus hard goods. The driver labor market will remain constrained as competing sectors of employment – construction, manufacturing and warehousing – remain robust. However, Wadewitz said the recovery in driver labor is “broadly consistent” with past cycles, suggesting “trucking company labor could return to the 2019 peak in 2H21.”
Wadewitz also likes broker C.H. Robinson (NASDAQ: CHRW) as the industry is approaching what he described as the “sweet spot of the TL cycle for brokers.” The company’s internal expense initiatives, including headcount reductions, along with its contracts resetting to reflect favorable spot rates, should allow for margin improvement. He acknowledged that investor sentiment is still low for the company but that recent channel checks “indicate broker performance improved meaningfully” in the fourth quarter, setting the company up to beat diminished expectations.
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