Trucking stocks have been trading at above historical levels as the number of mergers and acquisitions rise, freight demand improves, supply tightens and pending government regulations prop up shares of small- and mid-level freight companies, a transportation analyst said.
“While we generally agree with the fundamental enthusiasm heading into 2018, we see greater value opportunities in large cap transports, as lower relative valuations and equally compelling earnings outlooks likely provide a more favorable risk-reward spread at present,” Barclays analyst Brandon Oglenski said. In an industry update, “Deep Dive on 2018 Freight Outlook,” Oglenski provides analysis on the drivers of revenue, cost and earnings in freight transportation.
In 2018, trucking companies are expected to see earnings rise nearly 30%, and to reach this goal, they must see “robust revenue gains,” and hit merger and acquisition growth targets, Oglenski said. In 2017, freight pricing improved after several years of oversupply, and over the next year, rates should rise 3%, “which should support a generally robust pricing environment for all of transports given the outsized nature of the trucking market.” Also, the market has been enthusiastic about the mergers and acquisitions, including Knight-Swift Transportation Holdings, Hub Group and Heartland Express.
“On the cost front, driver pay is historically correlated with pricing, but we expect tepid inflation in 2018 to support cycle high incremental margins,” Oglenski said. Truckload carriers don’t have “much operating leverage given high driver turnover and the need to pay higher wages during periods of expansion.”
Companies are expected to control their costs and see “robust margin gains in 2018” along with a rise in top-line revenue. “We are modeling a more subdued cost outcome in 2018 following two years of challenged trucking market economics.”
Van Buren-based USA Truck recently increased its owner-operator pay to $1.05 per loaded mile, from 98 cents, said David Turner, senior manager of marketing. Also, a 23-cent fuel surcharge is added to the pay rate and became effective recently.
On July 1, ABF Freight, a subsidiary of Fort Smith-based ArcBest, implemented a 2.5% wage increase for its union employees, spokeswoman Kathy Fieweger said.
FedEx Freight offered the following statement on driver pay: “FedEx Freight has a long history of offering competitive wages to our drivers, and that will not change in 2017 or 2018. As in previous years, increase amounts will be driven by current market conditions.”
While margins for truckload carriers should be above average in 2018, asset-light brokerage and forwarding businesses should expect to see margins continue to fall, Oglenski said. Intermodal rates might rise slowly, but 2018 looks to be a stronger year. When business improves for asset-based carriers, it’s historically led to lower margins for asset-light brokers. Midcap stocks C.H. Robinson Worldwide and Expeditors International of Washington look to face continued headwinds as previous periods of cyclical margin compression have lasted for more than two years. Margin pressure will likely impact top-line revenue strength in the short term.
“Incremental margins are likely to be sub-optimal across businesses which rely on significant purchases of third-party capacity, including intermodal and asset-light subsectors,” Oglenski said. “More asset-intensive intermodal providers are likely better positioned in the near-term, as we expect typical counter-cyclical asset-light margin dynamics to continue to play out for several more quarters.”
Incremental margins for Lowell-based carrier J.B. Hunt Transport Services are expected to be 11%, and they are on average 16%.
Truckload carriers Knight Transportation and Swift Transportation recently merged, and the new company has a target stock price of $37, and is projected to have 2018 earnings of $1.60 per share and 2019 earnings of $1.85 per share. As a result of this and other mergers and acquisitions, Oglenski expects earnings for truckload to increase 28%, intermodal to rise 24% and asset-light to increase 11% in 2018.
“We model (XPO Logistics) at 47%, in line with consensus,” he said. Earnings for J.B. Hunt are expected to rise 18% in 2018 after falling 2% in 2017.
In 2018, organic revenue growth is expected in the mid- to high-single digits as trucking rates improve. Like previous years with significant rate increases, large trucking companies should see revenue rise. Average organic revenue should increase 5% for truckload, 11% for intermodal and 7% for asset-light and 5% for XPO. Truckload and intermodal providers are expected to increase capital expenditures, as a draw on cash, in 2018. J.B. Hunt is expected to increase capital spending by 1% in 2018.
Revenue growth for truckload, intermodal and asset-light carriers is “generally correlated with rate outcomes,” Oglenski said. Rates have recovered steadily over the past two years, setting up a “solid backdrop for top-line growth next year.” While labor costs have exceeded rates recently, rates and labor costs are expected to converge by the end of 2018.