The powerful surge in demand and pricing now coursing through transport modes will last through the rest of 2021, continue through all of 2022 and could extend well into 2023, Deutsche Bank analyst Amit Mehrotra said in a note published Monday.
Mehrotra, who has been bullish on transport stocks since 2018, turned up the volume in his missive, saying the macroeconomic tailwinds cited last November in the firm’s 2121 outlook have continued to surprise to the upside. According to Mehrotra, a recovery in U.S. industrial production, the release of pent-up consumer and housing demand, replenishment of depleted inventory levels, and the billions of dollars in federal spending from a potential infrastructure bill will keep shipping activity and freight rates highly elevated long after the COVID-19 pandemic is history.
Just as important, shipper psychology is shifting to support what Mehotra has called the “stronger for longer” pricing cycle. This is especially relevant to the $700 billion-a-year U.S. truckload sector, where stakeholder psychology is critical in assessing price volatility, Mehrotra said. An increasing number of truckload shippers, namely very large retailers, have already discounted higher transport spending levels in 2022, he said.
A supply chain executive at one of the world’s largest retailers said that 10% to 20% rate increases are baked in for this year and that further increases are expected in 2022, given strong year-to-date demand trends, Mehrotra said he was told.
It also appears that after a nearly two-year down cycle exponentially amplified by the pandemic, the U.S. industrial economy is poised to rebound, Mehrotra said. Industrial up cycles typically last more than three years, the analyst said. The consensus is that the domestic industrial economy began turning up late in the first quarter. If March 2020 was the starting point of the next uptrend, “there is plenty of growth ahead,” Mehrotra said.
LTL carriers are highly levered to industrial demand, and XPO Logistics Inc. (NYSE:XPO), one of the largest LTL carriers, may shed light on macro trends late Monday when it releases its first-quarter results after the market closes, and on Tuesday morning when it hosts its conference call with analysts..
The investment bank forecasts that transport companies, on average, will report 2021 earnings growth of 33%, a significant step up from the 20% increase that was forecast just last November. Earnings will increase 12% in 2022 over 2021 levels, up from the 10% gains projected back then, Mehrotra said.
The bank sees additional upside potential to its already-upgraded 2022 estimates, and Mehrotra expects upside earnings revisions to become the rule rather than the exception next year. Investors and analysts are still underestimating the strength and durability of the current cycle, said Mehrotra, who has arguably been the most vocal bull in the analyst community.
The pricing examples that Mehrotra cited are striking. LTL company Saia Inc. (NASDAQ:SAIA) achieved contract rate renewals of 9% in the first quarter, compared with 6% to 7% increases in the prior two quarters. Knight-Swift Transportation Holdings Inc. (NYSE:KNX) and Werner Enterprises Inc. (NASDAQ:WERN), two of the largest truckload companies, have revised pricing guidance to above the midteens range. UPS Inc. (NYSE:UPS) in its first-quarter results achieved 12.5% yield growth in its core U.S. ground parcel business, and the spread between package-delivery pricing and cost was a stunning 800 basis points.
Mehrotra acknowledged that the bank’s estimates are typically higher than consensus, and that lofty equity valuations give transport firms less margin for error in their earnings. He also noted that macro conditions could decelerate, as evidenced by Monday’s release of The Institute of Supply Management’s (ISM) April Purchasing Managers Index (PMI), which fell to 60.7% from 64.7% and came in below forecasts of 65% as shortages of inputs likely constrained production activity. However, the analyst said the very strong demand and pricing climate overshadows any possible clouds at this point in the cycle.
Deutsche Bank is bullish on parcel-delivery companies like UPS and rival FedEx Corp., (NYSE:FDX), truckload carriers, and railroads like Union Pacific Corp. (NYSE:UNP) and CSX Corp. (NYSE:CSX). Already-elevated LTL valuations create a higher investment bar, but potential earnings revisions should make room for expanded equity values, he said.