2 Top Shipping Stocks to Consider Buying Now -- and 1 to Avoid

Shipping companies have been trucking along nicely thanks in part to the continuing growth of e-commerce and home delivery. Investors can expect FedEx (FDX 0.11%) and XPO Logistics (XPO -3.06%) to show continued appreciation, while excitement about air cargo firm Atlas Air Worldwide (AAWW) appears to have gotten ahead of what the company can deliver. 

A FedEx truck preparing to head out on the open road. Image source: FedEx.

Long after the demise of e-Toys and other dot-bombs, survivors led by Amazon.com continue to grow in importance at FedEx and United Parcel Service (UPS 0.34%). Elsewhere transport and logistics giants including XPO, CH Robinson Worldwide (CHRW 1.54%), and JB Hunt Transport Services (JBHT -2.34%) have had success offering their traditional retail clients tools to better manage inventory for a dot-com world and handle home deliveries and installations.

But there are reasons for concerns about these new businesses. UPS and FedEx are spending billions on IT and infrastructure to keep pace with the surge in retail deliveries. And consumer deliveries are heavily weighted toward the last three months of the year, leaving the companies to scramble to staff up for the holiday season. UPS failed to staff up enough for Christmas 2013, and then blew the fourth quarter of 2014 in a failed attempt to overcompensate.

Making matters worse Amazon is moving parts of its logistics in-house. That's been great for Atlas Air, which is providing 40 freighter jets for what Amazon calls "Prime Air." But it could mean trouble for shippers who have grown reliant on Amazon revenues.

Data source: Yahoo! Finance.

Here are two stocks from the sector to consider buying now, and one to steer clear of.

Switching gears

FedEx founder and CEO Fred Smith made a bold statement during his company's fiscal first-quarter conference call back in September, declaring that "e-commerce is not going to eliminate the retailing sector of the country." The business, which represents about 10% of retail nationally now, will grow, he said, "but will it be half? I doubt it."

He might be right. But the company has also moved aggressively to build its e-commerce offering assuming online shopping does continue to skyrocket, and to thrive even if Amazon does take much of its own logistics business in-house.

The company in 2016 acquired Genco, a so-called reverse logistics firm that handles returns and repairs for e-commerce sellers. Genco is a nice add-on to attract shipping customers, giving FedEx the ability to manage a part of the business that if left in-house can be a major hassle for a retailer. FedEx believes it can operate the business more efficiently than Genco could as a stand-alone because the unit can piggyback on FedEx's existing delivery network, instead of having to pay to ship returned items to a central facility.

FedEx claims that returns represent between 20% and 30% of all e-commerce goods transported within its network.

FedEx also offers smaller retailers logistical services, including warehouse management and inventory fulfillment, and boasts that its network of facilities allows it to reach 94% of the U.S. population within two days through its ground service. As with Genco, this service is set up to help smaller retailers better compete against Amazon and should help FedEx to nurture non-Amazon clients and build a diverse base of retailers.

There's risk in buying into FedEx. The company's capex budget is large, with FedEx expecting to spend $5.9 billion in its current fiscal year to refresh its fleet, strengthen its IT, and expand capacity. It's also integrating TNT Express, which it bought in early 2016 for $4.8 billion to strengthen its European footprint.

FedEx is cheaper than UPS on both a price-to-trailing-earnings and a price-to-sales basis, but it does offer substantially less of a dividend yield than its archrival. The company in recent months has had to weather not just a series of hurricanes but a European cyberattack as well, and in September it lowered full-year guidance to a range of $11.05-$11.85 from a previous range of $12.45-$13.25.

But FedEx is also finding ways to cut costs. The profit improvement plan the company launched in October 2012 has resulted in $1.7 billion in gains to date and is expected to extract an additional $1.2 billion to $1.5 billion through fiscal 2020. The near-term could be choppy, but FedEx is moving aggressively to position itself to come out ahead no matter what Amazon thinks of next.

Going the distance

Rollup specialist Brad Jacobs in less than a decade has built what began as Express-1, a $177 million-in-sales trucking brokerage, into XPO Logistics, which now ranks among the nation's largest transport outfits. Jacobs has used M&A to build out a global footprint and expand into intermodal, freight forwarding, contract logistics, and other segments.

XPO's mission is to take on headaches such as supply chain management, getting goods through customs, finding available space on trucks, and optimizing route networks for customers, using its expertise, scale, and connections to make shipping more affordable than what most companies can do on their own. The business involves a lot of moving parts, but the segment that has attracted considerable interest from investors is its contract logistics and "last-mile" delivery services that are expected to grow along with e-commerce.

XPO is responsible for getting the sofa you purchase at Crate and Barrel or the appliance you buy from Home Depot delivered and installed in your house. As e-commerce grows from books and toys to larger, more complex, and more expensive heavy goods, that expertise figures to remain in demand, and large retail customers, for now, would rather partner with an XPO than take the work in-house. As long as XPO can provide a reliable service that doesn't generate consumer complaints, there's little reason for retailers to build out the capability on their own.

Rollups can be dangerous, as aggressive buyers can sometimes overleverage themselves to make that one last deal or fail to adequately focus on integration and lose out on much of what they acquired. But Jacobs has decades of experience in consolidation, doing more than 500 deals in his career while creating and building United Waste Systems and United Rentals before taking control of Express-1 in 2011.

XPO is no bargain, trading at 82.86 times trailing-12-month earnings compared with C.H. Robinson's 23.61 and JB Hunt's 27.43. It also doesn't offer the added attraction of a dividend. But given how fast the company is expanding, trailing ratios can be deceiving. The company's forward P/E, based on what analysts are expecting it to earn in the next 12 months, is a more comfortable 25.03.

The biggest risk to investors could be if Jacobs decides it's time to move on and explore something else. A bet on XPO since its formation has basically been a bet on the jockey more than the horse. As long as the CEO remains in place, this is a stock to own.

Atlas, shrug

While UPS and FedEx have been under pressure from Amazon concerns, Atlas Air has benefited from its newfound relationship with the e-commerce giant. Shares of the cargo air service operator are up more than 50% since early 2016, in large part because of the attention the company has received since the Prime Air partnership came to light.

The company's recent results haven't seemed so optimistic. Atlas in early November reported a third-quarter loss of $24.2 million. Backing out one-time costs and gains, the company's $1.08 per share in reported earnings still fell short of analyst estimates, despite beating on revenue.

An Atlas Air 747-8F cargo plane mid-flight. Image source: Atlas Air.

Company CEO Bill Flynn spent much of his time on the earnings call attacking the union representing Atlas pilots, saying Atlas saw a "significant increase" in last-minute sick and fatigue calls that disrupted schedules in what he called "violations of the Railway Labor Act" by the International Brotherhood of Teamsters.

Atlas in September requested a preliminary injunction to compel pilots to cease what it calls illegal work slowdowns. The Teamsters in response said Atlas' staffing problem is the result of "years of substandard pay, working conditions, and fatigue-inducing operations." Robert Kirchner, an Atlas Air pilot who is executive council chairman of the Teamsters local, said the company is "harassing pilots who are sick or fatigued."

It's nearly impossible for investors to figure out right from wrong in situations like this, but regardless, this dispute risks dragging on for months and creating ill-will that could last even longer. Combine the lofty valuation with the significant risk of ongoing labor discord, and there is no reason to buy in right now.