Chris Kent, co-manager of the Artemis US Select Fund, celebrates a 140 year anniversary today by highlighting the ‘significant’ investment opportunities within the Dow Transports index, as he concurs with the views of Warren Buffett, the sage of Omaha
It is often said that railroads were at the heart of the development of the American economy, peaking in 1916 with 254,000 miles of track and 1.8 million employees – more than any other industry1.
Less well known is the fact they made up most of the oldest US index, the Dow Jones Transportation Average (DJTA), better known as the Dow Transports, which was first compiled on July 3 1884.
It started with just 11 companies. Today, after 140 years, countless mega-mergers and the addition of industries that the original founders could barely even conceive of, it still numbers only 20 stocks.
The composition of broader equity markets has changed beyond all recognition in that time. They are now dominated by capital-light industries such as technology rather than capital-intensive ones such as manufacturing. Even so, the health of the transport sector remains an important barometer of economic wellbeing.
In Berkshire Hathaway’s most recent letter to shareholders, chairman Warren Buffett claimed this will still be the case in the extreme long term. He owns railroad operator BNSF in his portfolio and predicted that even a century from now it will “continue to be a major asset of the country and of Berkshire”2. “You can count on that,” he said.
Performance
The long-term performance of the Dow Transports index offers clues as to why it continues to attract serious investors.
In 1964 it first broke 200. By 1987 it was at 1,000. It carried on its steady rise to close above 9,000 on November 10 2014. At the end of May this year it stood at 15,238. Perhaps surprisingly, it is one of the few major US indices that investors cannot fully replicate with a passive index fund.
This shows that, while the index may be small in terms of the number of listed companies, the investment opportunities are significant – more so if you take a selective approach.
There are good “transport” companies with asymmetric risk/reward profiles. Their long-term outlook is promising, but their current share prices do not reflect that potential.
US transportation stocks have had a tough time over the past three to four years, with the sector in aggregate trading significantly below pandemic-era lows relative to the market.
We think this is primarily driven by excess capacity – which was added during the consumer goods/inventory boom in the face of COVID-19 – and underwhelming demand.
In our opinion, we are largely through inventory de-stocking. However, there is limited evidence of any meaningful re-stocking activity yet.
Cuts to earnings expectations have been widespread. For example, Knight Transportation, a well-run trucking business that we do not currently own, has seen its 2024 sell-side earnings estimates fall by more than 50%. Soft demand and excess supply have weighed heavily on pricing.
Yet we do see selective value in the space and are currently invested in two transport stocks. These are Saia, an LTL (less-than-truckload or small-freight volumes) company, and Norfolk Southern, a railroad business, which is one of the 20 companies currently in the index.
Saia
Saia has been a longstanding position for us and has grown from a regional LTL carrier into a national player. Over the years it has significantly improved its operating performance and gained market share.
Last year a major competitor filed for bankruptcy. Saia expanded into the space left behind without compromising on operating performance or price.
This year there have been some concerns about underlying growth in the sector. LTL volumes tend to be more focused on industrials, which have been sluggish. Consequently, there was a pullback in the stock.
However, in recent weeks we have seen encouraging updates from the company. It is opening around 15 new terminals, including some acquired through the competitor bankruptcy process, and shippers appear to be steering more volume its way.
Although in the short term we are mindful of the somewhat softer-than-expected backdrop, we see a long runway for growth – ultimately driven by an expanding geographic footprint and continued improvements in operating performance.
Norfolk Southern
East Coast railroad operator Norfolk Southern is a recent re-entry into our portfolio. Early this year it was the focus of an activist investor campaign, which, while not completely successful, saw the company overhaul and improve its board of directors.
This included major changes to management compensation and the appointment of an external chief operating officer with deep industry experience who joined from the newly combined Canadian Pacific Kansas City railroad.
We think these developments are sufficient to catalyse operating improvement, which tends to be closely correlated with profitability. That improvement, to us at least, does not appear to be reflected in the current share price.
Staying on track
There are many different factors affecting transportation stocks. In our opinion, taking a broad top-down view is not the correct way to generate investment returns in this space.
Businesses and the conditions they operate in constantly change, which is why, like Buffett, we think it pays to take a long-term approach. Forgive us, though, if we decline to commit for the full century.
