Transportation

Investors looking for a lower risk vehicle to participate in broad equity market strength than from chasing momentum driven areas with dubious fundamentals need look no further than the S&P rail index. Expectations have been crushed and valuations are on the cheap side of neutral. While rail freight is currently in a funk, leading indicators have perked up, particularly for the largest category, intermodal. The latter largely reflects the transportation of consumer goods. Thus, the surge in personal bank loans, strength in trucking tonnage and port traffic all bode well for a recovery in freight in the coming quarters. Against a backdrop of steep cost cutting, any stabilization in top-line performance should have an immediate positive impact on the bottom line. We upgraded to overweight in Monday's Weekly Report. The ticker symbols for the stocks in this index are: BLBG: S5RAIL: CSX, KSU, NSC, UNP. bca.uses_in_2016_08_03_001_c1 bca.uses_in_2016_08_03_001_c1

It is dangerous to equate recent equity strength with economic vitality, as history shows that liquidity-fueled equity advances favor non-cyclicals over deep cyclicals. Take profits in gold, buy rails and sell industrial machinery.

Airlines have been punished lately, trailing not only the S&P 500, but also their industrials peers. News that Delta would not meet already weak passenger yield expectations underscores that analysts still remain overly optimistic. Airlines have expanded capacity too aggressively while fuel prices were low, and are now being hit with pricing pressure as travel budgets are pruned. A simple airline margin proxy juxtaposing airline selling prices with fuel prices, signals that the industry's margin expansion will turn into a much steeper correction than analysts anticipate (bottom panel). As a result, profits are slated to underwhelm. Bottom Line: We are reiterating our high-conviction underweight stance in the S&P airlines index. The ticker symbols for the stocks in this index are: BLBG: S5AIRL - DAL, LUV, AAL, UAL, ALK. bca.uses_in_2016_07_07_002_c1 bca.uses_in_2016_07_07_002_c1

Transportation stocks are weak, reflecting profit warnings in both the trucking and rail industries. Air freight equities have been slightly more resilient, but the outlook for profits remains bearish. Global revenue ton miles are contracting, with weakness spread across all the major regions. High inventory-to-sales ratios in both developed and developing markets warn that demand for rapid delivery services will stay soft. The implication is that deflationary pricing power will persist, just as fuel costs have climbed anew. To make matters worse, FedEx stated that it was raising its capital spending outlook to better compete, continuing a trend of rising investment and growing capacity. Consequently, it will take a major resurgence in top-line growth to reverse deflationary tendencies and pressure on operating margins. Despite increasingly low valuations, we recommend staying underweight. The ticker symbols for the stocks in this index are: BLBG: S5AIRF - UPS, FDX, CHRW, EXPD. bca.uses_in_2016_06_23_001_c1 bca.uses_in_2016_06_23_001_c1

Airline stocks have been walloped of late, as the downside of an industry with high operating leverage is beginning to rear its head. The past few years of low oil prices and decent demand encouraged a large investment in capacity, which is now leaving the industry with an inability to fill planes at an attractive profit margin price point. Indeed, revenue per passenger mile is contracting and our proxy for global CPI airfares has plunged. We doubt that improvement is imminent, given that fuel prices are back on the upswing, and leading business cycle indicators continue to warn that retrenchment in travel budgets is a higher probability than expansion. Against this backdrop, airfare price concessions are likely to remain intact, or even intensify, to the detriment of airline revenue and profitability. We are sticking with a high-conviction underweight stance. The ticker symbols for the stocks in this index are: BLBG: S5AIRL - DAL, LUV, AAL, UAL, ALK. bca.uses_in_2016_06_15_001_c1 bca.uses_in_2016_06_15_001_c1

The previous Insight showed that rails are working hard to reduce cost structures. However, rail profits are still tightly linked with overall freight trends. The decline in total railcar shipment growth warns that rail earnings estimates will continue to lag those of the broad market. The two major freight categories are struggling. Coal shipments have plunged, with no imminent relief in sight, as utilities, the primary coal purchasers, are suffering from a contracting electricity production. Meanwhile, intermodal shipments, the largest freight category, have slipped into negative territory. Sagging port traffic, soggy retail sales and high inventory-to-sales ratios suggest that demand for consumer goods will remain lackluster. As a result, deflation is likely to prevail a while longer and we continue to recommend only a market neutral weight, despite the appearance of good value. The ticker symbols for the stocks in this index are: BLBG: S5RAIL - UNP, NSC, CSX, KSU. bca.uses_in_2016_05_18_002_c1 bca.uses_in_2016_05_18_002_c1

The relief rally in rail stocks has stalled at key resistance levels, but good value and extreme cost cutting efforts make it tempting to buy into any short-term weakness. Would that be a sound strategy? Top-line growth is lagging far below the rate of overall GDP growth, which is a bearish sign. However, rails have aggressively slashed costs, as both employment and capital spending have plunged. Moreover, the decline in railcar order backlogs suggests that new cars are coming on line. Rail operators lease the bulk of their cars, and tight supply in recent years boosted lease rates. As new cars hit the network, then lease rates should ease. These factors warn against extrapolating bearishness, but are they enough to bolster rail profits? Please see the next Insight. The ticker symbols for the stocks in this index are: BLBG: S5RAIL - UNP, NSC, CSX, KSU. bca.uses_in_2016_05_18_001_c1 bca.uses_in_2016_05_18_001_c1

Air freight stocks have been unable to gather speed during the most recent bout of overall market strength and bid under risky assets, reflecting long-term pressure on valuation multiples. Persistently high business inventories mean that companies are not under pressure to use rapid delivery services to fulfill customer requirements. Indeed, when inventories are tight and bottlenecks exist, demand for high margin freight services increase as businesses rush to catch up. This dynamic acts as a weight on valuation multiples for air freight companies, and is unlikely to soon change based on the downbeat message regarding global trade from the IFO survey (third panel). With global trade volumes barely growing and leading indicators warning of downside risks, the message is that air freight profits will have difficulty meeting lofty expectations, particularly now that oil prices are no longer falling in support of profit margins. We are underweight this index. The ticker symbols for the stocks in this index are: BLBG: S5AIRFX - UPS, FDX, CHRW, EXPD. bca.uses_in_2016_05_11_002_c1 bca.uses_in_2016_05_11_002_c1

Airline stocks have enjoyed some modest relief in recent weeks, but we expect this resilience to fully reverse. The main issue is overcapacity. Discretionary spending is under pressure, based on the message from global manufacturing woes and the plunge in the National Association of Restaurants survey (second panel). Airlines have been aggressively building capacity, as evidenced by the increase in airline capital spending. Long airplane production cycles mean there is a lag between spending and when new capacity will come on stream, and the tripling in airline parts & components inventory in the last eight years warns that the delivery pipeline remains full. Airlines are already resorting to price cuts to fill seats (bottom panel), which will drag on profitability. Importantly, future capacity increases signal that deflation will remain a prominent industry theme for the foreseeable future, and act as a weight on valuation multiples. Stick with a high-conviction underweight. The ticker symbols for the stocks in this index are: AAL, DAL, LUV, UAL. Airlines Are Running Out Of Fuel Airlines Are Running Out Of Fuel

The S&P rail index has bounced off its lows but continues to lack profit support to extend the recovery attempt. Total railcar shipments remain under pressure, which signals ongoing weak utilization rates and low odds of a reversal in selling price deflation. Coal markets are likely to stay under pressure as a consequence of high utility coal inventory levels, as electricity production was adversely impacted by an unseasonably warm North American winter. The latest retail sales report was also soft, and has sustained downward pressure on the retail sales-to-inventory ratio. That can be a decent leading indication for intermodal railcar shipments, the largest freight shipping category. Thus, despite attractive valuations and aggressive cost cutting efforts, we maintain a neutral weighting, preferring another industrials group to benefit from a slightly more reflationary tone in overall markets, please see the next Insight. The ticker symbols for the stocks in this index are: CSX, KSU, NSC, UNP. bca.uses_in_2016_03_16_001_c1 bca.uses_in_2016_03_16_001_c1