Sussing Out the Best of the Transports

 | May 24, 2013 | 12:00 PM EDT  | Comments
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Stock quotes in this article:

dal

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luv

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jblu

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nsc

Do you think the Dow Jones Industrial Average is having a good year? Just look at the Dow Jones Transportation Average, known as "the transports" for short.

While the Dow industrials have risen 16.7% through Thursday, the transports are up 21.2%. What should we read into that number?

Under classic Dow theory, initiated by Charles Dow more than 100 years ago, simultaneous strength in the industrials and transports means that an upward move in the stock market has staying power. Mr. Dow created the transportation index, originally called the railroad index, in 1884. That was a dozen years before he created his best-known index, the Dow Jones industrials.

Robust moves by the transports also signal that the old-fashioned cyclical portions of the economy -- those involving physical goods, as opposed to services, computer data or financial products -- are doing well.

At its birth, the transportation average contained nine railroads, one steamship company and Western Union (WU). Today it has 20 components that include railroads, airlines, trucking companies and some specialized transportation outfits.

The best performer among the transports this year is Delta Air Lines (DAL), whose shares are up 56% so far in 2013. After losing almost $9 billion in 2008, this company has now strung together three increasingly profitable years, with a profit of $1 billion in 2012 and expected earnings of $2.2 billion this year.

Delta shares sell for 10x last year's earnings and only 7x this year's expected earnings. Those are attractive ratios -- but you won't see me buying this stock, because I abhor Delta's balance sheet. The company has more than $12 billion in debt, and its net worth is negative to the tune of $1.9 billion.

I would prefer instead to own Southwest Airlines (LUV), which has a positive net worth of almost $7 billion. While it is nowhere near as cheap as Delta, it sells for 0.6x revenue and 1.5x value, which are reasonable multiples. The price-to-earnings ratio is 22x, but I expect its profit to double this year.

Another airline stock that bears watching is JetBlue Airways (JBLU), the only one of the 20 transports that sells for less than book value, or corporate net worth per share. It is tempting, but the balance sheet concerns me, as debt is 150% of equity.

In practice, I own none of those three airlines, but I do own one of the 20 transports personally and for clients. It is Norfolk Southern (NSC), a railroad that covers most of the eastern U.S. and hauls a lot of coal. I think it will benefit from an improving economy, and from a moderate comeback in coal shipments, as natural gas becomes a bit more expensive. Norfolk sells for 15x earnings.

John Dorfman is chairman of Thunderstorm Capital LLC, a money management firm in Boston. He can be reached at jdorfman@thunderstormcapital.com.

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