Transportation stocks have been the worst performing sector in the stock markets over the last year. These stocks are made up of airlines, railroads, truckers and shipping companies. But why? The economy has stabilized, interest rates are low, travel volumes are back up and commodities prices have tanked. The last point is key because oil and its derivatives such as gasoline, heating oil, diesel, jet fuel, etc. are major input costs for the transports. If input costs are low and demand remains the same, their margins, profitability and stock prices should improve. But that’s not playing out in the markets. The Dow Jones Transportation Average has lost almost one-third of its value from its peak in 2014 through Wednesday’s low. The average is made up of well-known names like United Parcel Service, Delta Airlines and Avis Car Rental. Let’s look at a few of the average’s sub-sectors within the transportation average for some clues.
Off the Rails
Railroads don’t have the same raw cost exposure to oil as some other transportation sectors. Consequently, they don’t benefit as much when the commodity sells off. Unfortunately, the rails are exposed to commodities through the freight they carry. When the commodities sink in price, there’s less demand and railroads naturally transport less volume, which means less profits. You can see this in a slackening of demand for new locomotive engines and cars. Industrial conglomerate General Electric (GE) this morning announced an 8% drop in industrial profits.1
Look at the plight of one iconic railroad company, Union Pacific. In the 1800’s, this company helped the U.S. claim our manifest destiny by stretching coast to coast. The story of the rail line’s construction is recounted in the Netflix series ‘Hell on Wheels’. The show chronicled the lives of ex-Civil War soldiers, from both fighting sides, and former slaves who traveled west looking for employment and a freedom.
Fast forward a century and a half and the company is in a very trying period. UNP stock is down roughly 44% since its all-time high of $124.52, just eleven months ago. This is significantly worse than the drop in the broader Dow Jones Transportation Average over that same time period. Further, the company announced it is furloughing 2,300 employees.2 Furloughs are mandatory periods of time off for workers without pay (although little comfort for employees, employees usually continue receiving benefits).
Fracking sand, crude oil and coal are some of Union Pacific’s normal freight, but volumes have been affected by either by the oil and gas slide or regulatory pressures, in the case of coal. So far, low interest rates have propped up one of Union Pacific’s best performing loads, automobiles. But a fear of higher interest rates and a potential auto loan bubble may have spooked some investors. Not helping the situation, Banc of America downgraded the stock from Buy to Neutral in December.
Another factor is potentially large hedge fund selling. According to Insider Monkey, a research site that tracks the insider transactions of hedge funds through filings with the SEC, 55 major hedge funds owned the stock as of the last quarter.3 The carnage in the hedge fund sector since last year has been accelerating as some hedge funds are forced to sell to meet redemptions, depending on their lock-up arrangement. That might explain the sheer voracity of the selling in the railroads.
Keep on Truckin’
OK, so why are trucking stocks in neutral? The American Trucking Association reveals that each 1% drop in fuel costs means industry wide fuel savings of $350 million.4 Yet, despite the continuing drop in diesel prices, the average marginal cost per mile keeps increasing due to hikes in driver wages and equipment purchases.5 Driver wages are being buoyed by an ongoing driver shortage. This is forcing trucking companies to pay up for experienced, qualified drivers. Many truckers fled the traditional long-haul routes for the shorter hours, and higher paying, jobs supporting the oil and gas boom in shale areas. In fact, hours of service was the number one industry concern among drivers for the third year in a row according to an annual survey done by the American Transportation Research Institute, ATRI.6 But as the shakeout continues in the shale industry, it is possible that many of the drivers return to their former companies in search of employment which would help alleviate the shortage. The silver lining is that wages might come back in line, making the trucking companies, and their stocks, more profitable down the road.
Ryder Systems is a well-known is a predominantly domestic U.S. trucker who has also seen its stock get bashed by investors, losing half its value since last just April. The stock has fallen out of favor as investors back away from companies with high levels of debt in its capital structure, of which Ryder is one.7 Also, the uncertain economy could affect selling of used-equipment. The stock has endured downgrades and lowered estimates from a bevy of Wall Street analysts over the last few months.
But no transportation sector has been hit as hard as the shippers. Shipping stocks have been a disaster with the Baltic Dry Bulk Index. One example is the plunge in charter rates for use of the largest shippers, the Capesize class (so-named because they cannot fit through the Panama Canal and must circle around ‘Cape’ Horn). Daily charter rates are down to $2,700 per day. Contrast this to the $250,000 day rates enjoyed by shippers during the manic boom of 2008!8 The two most often cited reasons for the crash are the overbuilding of ships in China over the last few years and global shipping seeing depression-level demand from a commodity collapse. The sobering reality of the 98% drop has placed this industry on life support and many companies are deciding to simply drop anchor and wait. The costs to run most Capesize ships is $7,500 per day so with rates just one-third of that, it’s a bankruptcy waiting to happen.9 One such company was Denmark-based Copenship who filed for bankruptcy last year. Some predict a wave of Chinese ship bankruptcies in 2016.
Many companies are trying to sell off assets (ships) to pay their debt off. Scorpio Tankers made the wrong bet on Capesize ships when it spent $1.5 billion for 28 of the behemoths between 2013 and 2014.10 Since then, Scorpio was forced to liquidate all 28 ships and incur a loss of $400 million, sending their stock, STNG, spiraling lower by 85%, according to the Wall Street Journal.11 The destruction in equity values can further be seen with the Greek company, DryShips, DRYS, who’s seen its stock price crumble from a high of $131.34 in 2007 to a current price of fifteen cents.
Up, Up and Away
Airline stocks have performed better than the other transports over the last year as the jet fuel cost-savings really help the bottom lines. Profits at Southwest Airlines (ticker ‘LUV’) based out of Dallas, have soared as increased travel demand and the wise decision to not hedge jet fuel price exposure have boosted its profitability. Deutsche Bank analyst Michael Linenberg was impressed with Southwest’s Return on Invested Capital and commented that every $1 drop in a barrel of jet fuel saves the airliners $400 million in pre-tax earnings.12 Deutsche Bank maintains a “Buy” rating on Southwest. Through 2015, Southwest’s stock has appreciated tenfold from its March 2009 lows. The airlines have had their share of bankruptcies over the years but for many of them, and their shareholders, they are enjoying a golden era today.
Where does the Road Map Say We’re Heading Next?
No one can say for sure why the transports are in the proverbial tank. The transports are a very cyclical group of stocks, leading some technical analysts to warn of a pending weak economy and broader stock market sell-off. “Dow Theorists” explore the relationship between the Dow Jones Industrial stocks and the transportation stocks. With origins over a century old, the Dow Theory was credited to former Wall Street Journal editor Charles Dow from 1900-1902. The theory basically says that the broader market moves with the transports but major changes follow when one diverges from the other in a meaningful (high-volume) manner.13 This is clearly occurring now as the transports are extremely weak and the Dow Industrials have held up much better.
Others dismiss the sell-off as simply overdue. They would cite that outside of biotech stocks, the transports bounced the highest off of the March 2009 financial crisis lows, more than quadrupling as a group from March 2009 lows to the November 2014 highs. So a sharp pull-back was probably overdue. Whatever happens, the transportation sector is an indispensable part of our economy and lives.