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Investing in transports: Analysts make their picks

Since the start of 2015, it's been a rocky road for transportation stocks. But that may be changing.

A truck loaded with cargo sets out from Kansas City, Mo.
Justin Solomon | CNBC
A truck loaded with cargo sets out from Kansas City, Mo.

The Dow Jones Transportation Average has shed more than 5 percent of its value since the start of the year, underperforming the broader stock market and posting its first quarterly loss in nearly two years. Worse yet, the index recently closed below its 200-day moving average, a key technical level that some worry could signal the start of an even steeper selloff.

Investors have been rotating out of transports in anticipation of expected weaker first-quarter earnings. As the Dow Jones Industrial Average has climbed to record highs this year, the sector has essentially moved sideways since November. That divergence has raised the jitter factor among traders and analysts.

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Shares of companies that focus on the transportation of industrial goods and commodities may be particularly worrisome, as low energy prices cut into demand for goods associated with oil drilling and manufacturing. Meanwhile, a stronger dollar is eroding foreign appetite for U.S.-derived commodities like coal and grain.

Keep on trucking

But for those willing to ride out the volatility, analysts say the broad selloff has also created some buying opportunities in key sectors.

"Stick with the truckload sector," said Jason Seidl, a managing director at Cowen and Company covering transportation stocks. "We have a pretty tight marketplace, with prices going up for the first time in many years."

Rates charged by trucking companies rose last year, and analysts largely expect that momentum to continue in 2015. Seidl sees prices climbing another 5 percent.

On the heels of crude oil's collapse, a gallon of diesel is now more than a dollar cheaper than it was a year ago. Full-truckload (TL) companies are among the biggest beneficiaries, and Seidl recommends those over names focused on less-than-truckload (LTL) operations.

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Cheaper fuel lowers operating costs, but it can also make trucking an attractive option to railroads, as lower diesel makes the cost of hauling freight over longer distances via truck cheaper.

Avondale Partners chief market strategist Donald Broughton added that, unlike railroads that transport commodities, the trucking group tends to do well when the dollar is strong. That's because many of those companies have largely domestic operations that are insulated from currency fluctuations, and they move consumer-oriented goods like those found at the big box retailers.

"Simply put, the cost of fuel and the value of the dollar hurts rails, and helps trucks," Broughton said.

Broughton and Seidl both recommend Swift Transportation, Knight Transportation, and a small-cap stock called Covenant Transportation Group, which recently hiked its first-quarter profit forecast by more than double its previous estimate, unlike other peers. Broughton also recommends Werner Enterprises.

However, one headwind to watch is a potential shortage of labor. According to the American Trucking Associations, the industry is in need of 35,000 to 40,000 drivers immediately. While higher wages have decreased the turnover rate for current drivers, the national trade association said the biggest companies still experienced an astounding 95 percent churn rate in 2014.

Elsewhere, shares of railroads have gotten off track after several years of gangbuster growth and stellar stock gains. In addition to the short-term effects of the West Coast port strikes that weighed on intermodal volumes, the stronger dollar and weaker commodity prices are also a drag.

Crude oil carloads—a high-growth, high-margin business—have begun falling as oil companies begin to scale back production. As rigs come offline because of the swoon in oil prices, volumes of materials used in drilling, like frack-sand and steel pipes, are also on the decline.

Coal—still one of the largest businesses for railroads—is a bigger worry, as demand for the dirty fuel plummets amid producers switching to cheaper and cleaner natural gas. Even so, the battered group may offer some deals.

"I like Canadian Pacific [Railway]. Earnings are likely to grow 25 percent this year, and likely to double between now and 2018," says Mark Levin, an analyst with BB&T Capital Markets. "All of this is predicated on the company continuing to improve operating efficiency, increasing car lengths and velocity."

In other words, CP is undergoing an extensive turnaround, as chief executive Hunter Harrison continues to revamp the Toronto-listed company's business.

Levin also recommends Union Pacific, a diversified western U.S. railroad giant that is poised to command higher prices from customers with new contracts resetting this year and next. He notes the railroad's been accelerating buybacks and hiking its dividend as well.

Still, investors may want to brace for a bumpy ride, because the overall rail group is poised for more pain as earnings season gets going. Rail giant CSX will kick off results after the bell next Tuesday.

According to Wall Street estimates, the sector is on track for its worst quarter of earnings growth since mid-2012.

High hopes for FedEx

Workers prepare to offload an incoming FedEx plane in Newark, New Jersey.
Getty Images
Workers prepare to offload an incoming FedEx plane in Newark, New Jersey.

For many of the same reasons trucking stocks could do well this year, analysts have high hopes for FedEx. It owns hundreds of cargo planes that benefit from cheaper jet fuel and could enjoy high package volumes as consumers spend more.

A majority of analysts have buy or outperform ratings on the parcel carrier's stock, according to FactSet, with an implied price upside of nearly 13 percent over 12 to 18 months.

Making shares potentially more attractive in the longer term is the company's acquisition of Dutch rival TNT Express, for the equivalent of $4.8 billion in cash. If the deal, announced Tuesday, goes through, FedEx is expected to expand its market share in Europe, particularly Ground operations. That would put it more directly in competition with the continent's two biggest shipping players, UPS and DHL.

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In a report, Rob Salmon, a transport analyst at Deutsche Bank, noted that the deal has "significantly larger integration risks than recent purchases (such as GENCO and Bongo)," since FedEx will make substantial investments in TNT's network once the deal closes, most likely in in the first half of 2016.

While he doesn't expect it to meaningfully affect earnings results until 2018, "We believe TNT Express will allow FDX to benefit from an eventual European economic recovery, growth in cross-border trade [and] increased e-commerce penetration in Europe," among other factors, he added.

Meantime, Salmon has pointed to management's ongoing execution of a cost-cutting profitability plan in the Express division and its growth in Ground shipping, a high-cash-flow, high-margin business, as two reasons to be positive on the stock.

Disclosure:

Donald Broughton and Avondale Partners do nto own Swift, Knight, Covenant, or Werner

Mark Levin does not own Canadian Pacific or Union Pacific. BB&T Capital Markets does not own either stock but makes markets in both.

Rob Salmon and Deutsche Bank do not own FedEx.

Jason Seidl and Cowen & Co. do not own Swift, Knight or Covenant.