In a research note this morning, Morgan Stanley analyst Ravi Shanker told investors that it was time to get cautious on freight transportation stocks as he sees downside risk to consensus in 2019 across virtually the entire group driven by slowing demand fundamentals. In conjunction with his change in the sector rating, the analyst downgraded Union Pacific (UNP) and Genesee & Wyoming (GWR) to Underweight and cut Old Dominion (ODFL) to Equal Weight. DOWNGRADING INDUSTRY VIEW TO CAUTIOUS: Moving his industry view to cautious, Morgan Stanley's Shanker argued that he sees downside risk to consensus in 2019 across virtually the entire freight transportation group driven by slowing demand fundamentals. Yet, valuations remain elevated across most of the group, he said. The analyst trimmed his estimates across the board by about 2%, on average, for FY19-21. However, Shanker noted that he is not calling for a macro recession in 2019. Instead, he is concerned that 2019 could be similar to 2015-2016, when the transportation complex went through a freight recession even as the overall economy held up. SELL UNION PACIFIC, GENESEE & WYOMING: Morgan Stanley's Shanker downgraded Union Pacific to Underweight from Equal Weight, saying that while he has always viewed it as "the most defensive" among the U.S. rails given its long LoH, PRB coal exposure, and relatively low IM risk, he now sees risk as too high if the cycle turns. Specifically, Shanker pointed out that his firm's coal team has turned more bearish on domestic coal demand in 2019, and added that the frac sand risk that he highlighted last year looks like it would materialize in early 2019. Union Pacific's struggles to grow pricing when the market is firing on all cylinders raises concern on what pricing net of inflation will be like next year given the increase in rail inflation expectations, he contended. Additionally, the analyst believes the company's PSR implementation carries "significant execution risk" and the goal appears to be a stretch relative to expectations. Meanwhile, Shanker also downgraded Genesee & Wyoming to Underweight from Equal Weight arguing that if the truckload market loosens up driven by decelerating demand and industrial end markets weaken from here, Genesee will be the rail "most exposed" to topline headwinds. Noting that about 20% of the company's operating income is from Australia and U.K./Europe, the analyst pointed out that Genesee & Wyoming's Australia business faces risk of decelerating growth in China and the U.K./Europe business faces risk of Brexit uncertainty. Moreover, Genesee & Wyoming is also the most levered rail, making it exposed to rising interest rates, he contended. MOVING TO SIDELINES ON OLD DOMINION: Despite the recent selloff in the stock and it remaining his favorite less than truckload name, Morgan Stanley's Shanker downgraded Old Dominion to Equal Weight from Overweight. The analyst noted that Old Dominion's absolute and relative tonnage growth turned as scheduled three months ago but the stock did not reciprocate as it typically does. It now appears that the stock is catching up but has "a ways to go to close the relative valuation gap to the truckloads," Shanker added. While the analyst thinks that if macro does start to slow, LTL stocks will feel it, he still believes Old Dominion will hold up better than peers given its defensive nature, superior margin profile and relatively bearish investor positioning. PRICE ACTION: In morning trading, shares of Union Pacific have dropped almost 1.5% to $146.57, while Genesee & Wyoming's stock has slipped about 3% to $79.02. Also lower, shares of Old Dominion slid over 1% to $130.27.
