Investors seem to be increasingly asking the question: What is the fair price for a quality transportation company? With many traditional valuation methodologies reverting to mean historical multiples, investors could make the case that many transportation stocks are nearing ‘full’ valuation. However, with lower multiples relative to other large industrial companies and near top quartile return generation, certain ‘quality’ stocks within the group deserve a wider comparison universe apart from the usual suspects.
In this note, we take a fresh view on valuation for the largest and highest return companies. Slow growth and a rapidly appreciating market make stock picking a challenge for sell-side analysts and investors alike. It is surely acknowledged that upside from here in many stocks is challenging, at least through the cautious outlook. However, the chase for yield is powerful and has us revisiting what to pay for the high return generators in the transportation group.
Screening the best transportation companies
We run a screening test on three filters:
1) Capital returns
2) Cash flow generation
3) Annual earnings growth
Results highlight that top performing transportation companies Canadian National Railway (USA) (NYSE:CNI), Union Pacific Corporation (NYSE:UNP) and United Parcel Service, Inc. (NYSE:UPS) screen favorably relative to both respective sub-sector and industrial peers, making a strong case for the ‘top-quality transport companies.’ These three companies ranked in the top two quartiles in terms of capital returns and potential earnings growth, while also screening favorably in terms of cash flow generation:
*Qtl denotes Quartile.
Union Pacific remains a top holding
Admittedly, Union Pacific Corporation (NYSE:UNP)’s share performance this year (+9% vs. S&P) has captured a majority of the expected upside. But with an improving return and cash generation profile as well as higher near-term growth expectations, the shares are expected to benefit from an improved relative multiple, similar to other large industrial companies.
The railroad has been one of the most popular transportation companies at the Street for its potential growth. Its western network has helped it to benefit from the rising demand for crude oil in domestic energy markets. Not only this, the network has also helped the company to transport automotives and hence benefit from the rapidly surging US auto SAAR (seasonally adjusted auto rate).
However, this should not mean the peak for Union Pacific Corporation (NYSE:UNP). The company is still expected to make a business of $850 million by transporting crude oil by 2014. This would equal almost 4% of the overall revenue for the company. Also, the carrier is expected to benefit from pricing gains in its southern network where it is operating on near capacity conditions.