By Jack Hough

A three-year freight recession shows signs of easing. Sizing up rail and trucking stocks from here requires the usual economic forecasting and operational analysis, plus some tariff game theory and climate modeling. Consulting a shaman is optional but recommended.

Factoring in most of these things, the overall transport outlook is better than bad, but not necessarily good, says Evercore ISI analyst Jonathan Chappell. The best stock opportunities are in companies that can bootstrap better results even if outside factors don't fully cooperate. Four names below.

Consider, first, the U.S. economy. A strong Jan. 10 jobs report sent the Dow Jones Industrial Average 697 points lower, and then an inflation reading five days later sent it 703 points higher. That's a tidy net gain of six points, plus free excitement of the kind that bungee jumpers and mechanical bull riders pay good money for. The stock swings reflect investors flip-flopping on the outlook for more interest rate cuts. Inflation saved the day, with help from selective measurement and rounding rules.

The overall inflation rate accelerated to a seasonally adjusted 0.4% for the month of December from 0.3% in November, which isn't ideal for rate cut hopes. But if we use full-year inflation, and strip out energy and food, we get 3.2%, whereas economists were predicting a fourth straight month with a 3.3% reading -- hoorah. Technically, the latest number is 3.248%, which is two one-thousandths of a point away from being rounded up to 3.3%, not down. So we beat expectations with an entire thousandth of a point to spare -- and to think I was worried.

Extrapolating that to 2025 is difficult, but at least financial markets were recently pricing in a 92% probability of a first-half rate cut, up from 68% before the inflation report. Considering that, I'll rate the U.S. economy as "decent" -- the more upbeat usage of the word, like by a 1982 arcade kid getting a free guy on Centipede.

Tariffs are trickier, and not just because we don't yet know the timing, scale, and response. The normally cyclical transport business has looked closer to manic in recent years. During the Covid-19 pandemic, consumer demand shifted sharply from services to goods. Supply chains snarled, prices soared, and retailers that got caught short for Christmas 2020 bought extra for 2021. Trucking companies ordered new rigs. By the time they were delivered, demand had eased, retailers were destocking, and a transport downturn set in by mid-2022. A typical one of those lasts five to seven quarters, peak to trough. Not this time.

"They made so much money, truck drivers, that they weren't removing capacity when things started to turn negative," says Evercore's Chappell. The downturn lasted until the fourth quarter of 2024. What should follow now is a recovery in industry pricing, company earnings, and share prices. Careful there, however.

The problem is that recently robust shipping container imports have bucked normal seasonal trends and outpaced final retail demand. It looks a lot like a pulling forward of demand, and one reason for that could be buyers getting ahead of tariffs. "Managers weren't playing chicken with, 'Oh, I don't think Trump's gonna win,' and 'I don't think there's gonna be tariffs,' " says Chappell. The last time that tariff fears sparked a big demand pull-forward, in late 2017 and early 2018, it led to a slump. That could happen again. Meanwhile, trucking companies might not yet have purged enough capacity to ensure firmer industry pricing.

If shares were trading at beaten-down valuations, these nuances might not matter as much. But that's not the case. "These stocks had ripped on this thesis of the end of the freight recession and the Trump trade, and the multiples were numbers we've never seen before," says Chappell. "We had to change the y axis on our historical valuation models."

Knight-Swift Transportation Holdings traded recently at 51 times depressed 2024 earnings forecasts, on the assumption that earnings will rebound smartly from here. On the same basis, Schneider National recently sold for 42 times earnings, and Werner Enterprises, 54 times. If consumer purchases pick up, the surge in imports might not turn into an inventory glut. Manufacturing growth would help, too. But for now, favor self-help companies.

Chappell likes C.H. Robinson Worldwide, a player in shipping logistics, a business that is sometimes subject to cutthroat pricing. New management has been investing in technology and gaining share in higher-margin business. Shares go for 24 times last year's earnings estimate, with Wall Street anticipating double-digit earnings growth rates this year and next.

Saia and XPO both operate in the LTL, or less-than-truckload, business. Big customers that can fill entire trucks with freight can operate their own fleets, or demand discount prices from truckload operators. Smaller customers must pay more to deal with LTL companies and their networks of terminals, so profits there are more favorable. Saia in recent years bought dozens of terminals from bankrupt rival Yellow, which should allow for years of robust earnings growth. Shares go for 34 times estimated 2024 earnings.

XPO, meanwhile, has brought in executives from top industry operator Old Dominion Freight Line to improve efficiency after some iffy acquisitions in past years. It lacks the revenue growth of Saia but has plenty of room for higher margins. Shares go for 37 times estimated 2024 earnings, with Wall Street predicting 30% earnings growth both this year and next.

Chappell isn't as keen on rails, which were hit last year by wildfires, storms, a bridge collapse, and work stoppages, and which, after years of driving efficiency higher, now appear to have plucked the low-hanging fruit. But last month he upgraded Canadian National Railway to Outperform from In Line. It has been particularly subject to bad luck and earnings shortfalls, which had sent shares down 19% over the past year, not counting dividends. At 20 times earnings, and with growth in earnings set to resume at double-digit percentages, the stock could be due for a comeback.

Write to Jack Hough at jack.hough@barrons.com Follow him on X Subscribe to his Barron's Streetwise podcast

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January 17, 2025 03:00 ET (08:00 GMT)

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