Have Transport ETFs Been Derailed By Weak Revenues?

Unlike many recent quarters, the transportation sector lagged in Q2 as a strong dollar ate away most of the revenues of big transporters.

This is especially true as total earnings from 98% of the sector’s total market capitalization reported are up 9.4% while revenues declined 1.9%. This is much lower than Q1 earnings growth of 38.7% and revenue growth of 2% for the same period. Further, earnings surprises were predominantly weak with 58.3% of the companies beating earnings estimates and only 8.3% beating on revenues (read:ETFs to Play 3 Undervalued Sectors).

For a better understanding, let’s dig into earnings results of some well-known industry players:

Transportation Earnings in Focus

The world's largest package delivery company – United Parcel Service (UPS -Analyst Report) – beat our earnings estimate by 9 cents but revenues of $14.1 billion fell shy of our estimate of $14.5 billion. The company continues to expect earnings per share of $5.05–$5.30 for fiscal 2015, representing 6–12% growth on an annual basis. The midpoint is above the Zacks Consensus Estimate of $5.18 at the time of reaffirming the guidance. In fact, FedEx stated that earnings could be on the high end of the guidance range.

Union Pacific (UNP - Analyst Report), the U.S. largest railroad, reported earnings of $1.38 per share outpacing the Zacks Consensus Estimate by four cents but revenues of $5.43 billion fell short of our estimate of $5.67 billion. Other major railroads like CSX Corp. (CSX - Analyst Report) and Kansas City Southern (KSU -Analyst Report) also missed on the revenue front. Revenues at CSX lagged the Zacks Consensus Estimate by $78 million while KSU revenues declined  by 32 million. However, CSX outpaced our earnings estimate by 3 cents and KSU met our earnings estimate of $1.03.

Ryder Systems (R - Analyst Report), the leader in supply chain management and fleet management services, topped the bottom line but lagged the top line. Earnings per share of $1.65 are above the Zacks Consensus Estimate of $1.63 while revenues of $1.66 billion were below our estimate of $1.69 billion.

The two largest U.S. airlines – Delta Air Lines (DAL - Analyst Report) and United Continental (UAL - Analyst Report) – also beat our earnings estimate by a nickel and a couple of cents, respectively. Revenues for Delta were slightly above the Zacks Consensus Estimate but below for United Continental (read: Air Stocks and ETF Plunge: Warming Up for Summer?).

Last but not the least, the leading trucking carrier – J.B. Hunt (JBHT - Analyst Report)– missed on both earnings and revenues. Earnings per share of 88 cents fell short of the Zacks Consensus Estimate by a couple of cents while revenues were $69 million below our estimate.

ETFs in Focus
Despite the string of Q2 revenue misses, transport ETFs have managed to hold up well from a one-month look and are in focus for the days ahead. Both iShares Dow Jones Transportation Average Fund (IYT -ETF report) and SPDR S&P Transportation ETF (XTN - ETF report) are up 4.2% and 2.1%, respectively. Both funds have a Zacks ETF Rank of 3 or ‘Hold’ rating with a High risk outlook.

IYT

The fund tracks the Dow Jones Transportation Average Index, giving investors exposure to the small basket of 20 securities. The fund has a certain tilt toward large cap stocks at 46% while mid and small caps account for 35% and 19% share, respectively, in the basket. The product is heavily concentrated on the top firm – FedEx (FDX - Analyst Report) – at 12.7%, followed by UPS, KSU and UNP with over 7% share each. Other firms hold less than 6.4% of IYT (read: Will FedEx Q4 Spell More Trouble for Transport ETFs?).

From a sector perspective, air freight & logistics takes the top spot with less than one-third of the portfolio while railroads, trucking and airlines round off to the next three spots with double-digit exposure each. The fund has accumulated nearly $815.9 million in AUM while sees solid trading volume of more than 430,000 shares a day. It charges 44 bps in annual fees.

XTN

This fund uses the equal weight methodology for each security by tracking the S&P Transportation Select Industry Index. Holding 49 stocks in its basket with AUM of $328.1 million, each security accounts for less than 3.1% of total assets. The ETF is skewed toward small caps at 55% while mid and large caps account for 24% and 21% share, respectively.

About one-third of the portfolio is dominated by trucking while airlines take another one-fourth share. Airfreight & logistics, and railroads also make up for a double-digit allocation each. The fund charges 35 bps in fees per year from investors and trades in a moderate volume of nearly 66,000 shares a day (see: all the Industrials ETFs here).
 

Bottom Line

Amid a challenging Q2 earnings environment, the transportation ETFs gained momentum on better job conditions, cheap fuel and a strengthening economy. This trend is likely to continue in the coming months as well given that about 57% of the industry falling under this sector has a good Zacks Rank in the top 43%. Further, ETFs could be better ways to play the sector with lower risk as these could easily counter shocks from some of the industry’s biggest components.