Deutsche Bank Slows Approach to Transportation Stocks in 2022

One of the most bullish transportation analysts on Wall Street has tapped the brakes on his approach to selecting equities in 2022. In a Monday report to clients, Deutsche Bank analyst Amit Mehrotra advocated for a more selective stance on transport stocks in the coming year, citing inflationary concerns as a reason to avoid names trading at peak valuation multiples.

Mehrotra noted that inflation historically drives equity multiples lower and that "the easy monetary and generous fiscal policies that have propelled consumer wealth and spending to all-time highs are now largely in the rearview mirror," the Deutsche Bank DB report read. He pointed to the fastest inflation growth rate in 30 years as reason to take "a more disciplined approach to stock selection."

"The net result is still an overall positive stance on transportation equities in 2022 and plenty of compelling investment opportunities, albeit with a stock selection framework that is more sensitive to valuation than we've ever presented before," Mehrotra stated.

He lowered ratings from ‘buy" to "hold" for "high flyers" like Saia Inc. SAIA, UPS UPS, and Canadian Pacific CP, primarily citing valuation as the reason.

"Unapologetically bullish" on Saia's terminal expansion and freight rerating, which is aimed at taking yields and margins higher, shares of the less-than-truckload carrier have surged 400% since Mehrotra's upgrade nearly three years ago. Given the stock's run "risk reward is balanced over the midterm given our macro valuation concerns," Mehrotra said, hence the "hold" rating.

He said Saia still has the ability to produce $20 in earnings per share over time, which is likely more than double what the company will record in 2021.

A 120% run in UPS' stock price (up 70% versus the S&P 500) since upgrading it less than two years ago compelled Mehrotra to hit the pause button. He prefers FedEx FDX instead given its relative share price underperformance.

He also pointed to UPS' mid-2023 contract renewal with the Teamsters as a concern given the recent election of new union leadership. A new stance from union officials "looking to extract more value for its members in a rising inflation environment" could make negotiations the "most tumultuous since the 15-day UPS work stoppage in 1997."

He favors the non-union model at FedEx, which already accounts for recent labor inflation. The thought is UPS' contractual annual increases haven't kept pace with market pay rates.

A downgrade of Canadian Pacific also pointed to the amount of debt and equity the company is deploying to execute the acquisition of Kansas City Southern KSU ahead of the deal's final approval. Mehrotra said the company's 2023 consensus estimate, the basis for valuation, may be a little too high as well.

"The bottom line is we believe the near-term risks associated with higher debt and equity [plus] optimistic EPS expectations has potential to more than offset the long-term benefits of the KSU acquisition over the course of 2022," he added.

Mehrotra said he's bullish on companies that have the best chance for upside to 2023 consensus and the ability to see valuation multiples step higher, which he admits is "a high bar at this point in the cycle."

He sees the most potential in XPO Logistics XPO. "Over the course of 2022, we expect XPO to evolve from a hard-to-own conglomerate to a LTL pure play with plenty of profit potential," Mehrotra said.

XPO spun off its contract logistics business, which now operates as GXO Logistics GXO, this summer.  

Mehrotra pointed to recent media reports suggesting XPO is shopping its European transportation and domestic intermodal units, moving it closer to becoming a non-union LTL carrier exclusively. Less-than-truckload stocks have soared post the pandemic's onset. A mix of high consumer demand, a steady-demand industrial complex, and constrained trucking capacity have allowed carriers to focus on yields and improve margins and earnings.

"We view XPO shares as the most dislocated in our coverage universe with respect to earnings expectations and valuation, and shares have potential for upwards of 70% return, in our view."

He believes the sale of these non-LTL units will allow XPO to pay off debt and focus on improved execution in the LTL business.

"The good news is that the transportation sector as a whole appears well positioned for the end of a multiyear period of valuation expansion," Mehrotra continued. "Companies and subsectors have embraced technology to become more productive, balance sheets are being deployed accretively, carriers are no longer commodities, and there are more analytics and discipline on pricing and returns."

He said transport valuations are still attractive compared to the rest of the market. In addition to XPO, FedEx, and GXO, he sees potential for the most stock price appreciation in truckload carriers Werner Enterprises WERN and Knight-Swift Transportation KNX and railroads CSX CSX, and Union Pacific UNP.

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