These “Hated” Stocks are Some of the Best Bargains in the Stock Market

A funny thing happened on the way to disaster… nothing. In fact, nothing has happened on the way to disaster twice now — once in the middle of 2011, and then again in early 2012. 

The so-called disaster I’m talking about was the demise of the transportation industry. When things started to (seemingly) turn sour for the economy in mid-2011, rail stocks like Norfolk Southern (NYSE: NSC) and CSX Corp. (NYSE: CSX), along with trucking stocks like Werner Enterprises (Nasdaq: WERN), suffered more than their fair share of selling. CSX, for instance, had fallen 30% from its high by the middle of last year. Werner shares fell 25% from their high point to their low in 2011. 

Though not as drastically, these same stocks took big hits in early 2012 when things got bumpy for the economy again. As a matter of fact, the sector has been underperforming the rest of the market for a year and half. 

The question is, are investors simply coming to the wrong conclusions? If so, then the transportation industry may be one of the market’s best values right now.

Still rolling
The reasons for worry weren’t unreasonable. Though the weakness started to set in a little beforehand, the tsunami that devastated Japan in March of last year was presumed to be the beginning of a massive economic slowdown. After all, Japan is the world’s third-largest economy, and though its contraction may not have affected North American shippers directly, the ripple effect of its implosion would surely crimp U.S. shippers. 

But it didn’t. 

Werner’s year-over-year earnings per share were higher in every quarter last year. The same goes for Norfolk Southern. And even United Parcel Service (NYSE: UPS), which   as you probably know ships personal parcels worldwide, also pumped up its year-over-year bottom line comparison in all for quarters of 2011, along with most other shipping companies. 

OK, so the feared slowdown from 2011 never materialized. But since the European financial crisis is far bigger now than the fallout from Japan’s tsunami was then, surely the tumble from transportation stocks in the early part of 2012 is reflecting a new, serious struggle for the industry, right?

Eh, no — not yet anyway. 

Although the European debacle has been brewing since late last year, U.S. transportation stocks have yet to stumble because of it. Werner, UPS, Norfolk Southern and most other companies in the transportation industry did better in the first quarter of this year than they did in the same quarter last year. Their second-quarter numbers are expected to be higher as well. 

Said another way, if there’s trouble, then the industry’s results sure have a funny way of showing it. 

It’s not just some clever accounting that’s making these companies’ numbers grow, either.  There is more shipping activity. The American Trucking Association’s Tonnage Index reached an all-time record level in January of this year, meaning trucks carried more goods on U.S. highways that month than they ever have before. The index has fallen a bit since then, but considering trucks do about two-thirds of the nation’s hauling work, it’s tough to argue the industry’s in big trouble.

Picks of the litter 
The moral of the story is, though investors have been betting against the industry for more than a year, they’ve been flat wrong. The industry is still going strong. The end result is a group of stocks that’s undervalued by about 20% by my estimate.

Among the best of the best opportunities I see in this space are the aforementioned Werner Enterprises along with parcel shipper FedEx (NYSE: FDX)

Werner isn’t going to win any value awards by trading at 16 times trailing earnings. But, with earnings growing by 27% last year and expected to swell by 15% this year — not to mention it’s had a handful of earnings “beats” in its recent history — the forward-looking price-to-earnings (P/E) ratio of about 15 may underestimate this company’s potential.

The driving force for the next phase of its growth is the surprising, sustained rebound in construction activity. The number of new housing starts has grown by roughly 50% since the April of 2009 trough, and is still on the rise. 

As for FedEx, the stock is attractive because it’s lagged more than most other major transportation stocks for the past couple of years, thanks to a technical ceiling at $97.30. Yet, the company’s bottom line has grown from $3.76 per share in fiscal 2010, to fiscal 2012’s (ending last week) $6.59 per share. That’s a 75% growth in earnings in two years, but yet there’s been practically no change in the stock’s price during this timeframe. That can’t last long. 

The lack of progress from the stock has left it trading at only about 12 times the current year’s forecasted income, and only about 10 times the next year’s expected bottom line. 

This income-growth outlook is a tall order to be sure. But, if FedEx’s forecasters are on target with their expectations of 2.2% growth in this year’s gross domestic product (GDP) and 2.4% for next year’s GDP growth, then those estimated income levels should be well within reach.

Risks to Consider: Federal Express’s GDP outlook underscores the big risk for the entire transportation sector — it all hinges on sustained economic growth of at least 2.0%. Anything less, and earnings growth could be in jeopardy. 

Action to Take –> It’s not necessary to load a portfolio up with every stock suggested above. But, given the wall of lingering worry for many of these stocks, now’s a great time to step into one or two of them. FedEx may be the best first choice based on a combination of fundamental and technical factors. In fact, it’s one of the cheapest big names in the industry at this time. Income is expected to grow by 15% this year as well as next year, and if the share price can get above the nagging ceiling at $97.30, then the stock should be poised to break out.