Transportation takes center stage

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Michael Fowlkes 01/27/2014

We are in the midst of another earnings season and last week the transportation sector took center stage, with a number of large stocks reporting their quarterly results.

On Tuesday, Delta Airlines ( DAL ) got the sector off to a positive start when it reported strong fourth quarter results. The airliner posted earnings of 65 cents per share, higher than the 63 cents analysts expected. A major reason for the better than expected numbers was lower fuel costs during the quarter. Revenues were up 6% during the quarter.

Alaska Air ( ALK ) also posted better than expected earnings, as did Southwest Airlines ( LUV ). In both cases, lower fuel costs were a factor.

Looking forward, I am bullish on the sector. Consolidation within the industry is allowing for steady fare increases, and lower fuel costs should continue to help boost profits. The economic crisis was particularly tough on the entire sector, but it managed to turn things around in recent years, which by all accounts was no easy task.

If airlines were able to turn things around in a global recession, with high fuel costs and a weak job market, the future could be equally as bright now that fuel costs are lowering and the global economy continues to improve.

However, while I am bullish on the sector, there is always the chance that things could move in the wrong direction. A quick spike in oil prices could hurt the sector, as could a deterioration of the global economy. Neither is expected to occur in 2014, but it is impossible to rule out either possibility.

Switching over the railroad sector, Union Pacific ( UNP ) posted its fourth quarter results on Thursday, reporting better than expected earnings and revenues. Earnings during the quarter were $2.55 per share, topping the $2.49 analysts had forecast. Revenues during the period were $5.63 billion, higher than the $5.57 billion Wall Street expected.

Another railroad company to post strong quarterly results was Norfolk Southern ( NSC ). Its fourth quarter income jumped 24%, and it reported earnings of $1.64 per share, easily outpacing the $1.51 analysts had forecast. Revenues were also better than expected, climbing 7.5% year over year.

However, not all railroad companies were as strong during the quarter. A big earnings miss by Kansas City Southern (KSU) resulted in a steep selloff of its stock. KSU posted earnings of $1.03 per share, missing estimates by 7 cents. On the bright side, revenues were up 8.4% from the same period last year, and were in-line with analyst estimates. Regardless of the revenue increase, the stock quickly dropped 13% following the report.

Weakness in the coal industry continues to be a problem for the rail sector, but increases in general merchandise shipping are offsetting the problem. This was clearly seen in the Union Pacific report, which showed strong gains in both automotive and industrial shipments, which offset a 10% drop in coal deliveries.

Improvements in the housing and auto market are expected to continue in 2014, which should help boost shipment volumes for railroad companies. As a result, I am bullish on the sector going forward, but we must remain cautious due to the large exposure most railroad companies have to the coal industry.

Looking at transportation stocks on the whole, I have a bullish outlook. I expect that the global economy will continue to improve in 2014, which should benefit transportation stocks across the board. However, any trade I set up on the sector I would prefer to be hedged, and highly diversified, just in case the sector does run into trouble.

A perfect way to accomplish this would be a hedged trade on iShares Transportation Average (IYT). IYT is set up to track the Dow Jones Transportation Average, so it tracks the transportation sector pretty closely. Among its top holdings are Union Pacific, FedEx (FDX), Kansas City Southern, United Parcel Service (UPS) and Alaska Air.


Chart courtesy of stockcharts.com

A nice hedged trade on IYT would be the June 111/116 bull put credit spread. In this trade, you would sell the June 116 put while buying the same number of June 111 puts for a credit of 45 cents. This trade has a target return of 9.9%, which is 24.4% on an annualized basis (for comparison purposes only). IYT is currently trading at $131.05, so the trade has 11.1% downside protection.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

Originally published on InvestorsObserver.com


This article appears in: Investing , Options

Referenced Stocks: ALK , DAL , LUV , NSC , UNP

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