IYT: Likely No Margin Of Safety

The iShares Transportation Average ETF (BATS:IYT) contains a lot of decent exposures. Airlines likely cannot do any worse than they did during COVID-19 if a recession hits. Logistics earnings quality is decent, although they are exposed to a goods downturn. Railroads have a lot of advantages that keep their multiple really high. However, there are enough risks on the horizon where the multiple above 15x just doesn't provide enough margin of safety in our view.

Concerns

The sectoral chart gives a good idea of the IYT exposures.

The first allocation to comment on is passenger airlines, whose economics are going to be very different from the other logistics exposures in the IYT. These companies are generally going to be recession exposed, even though there is some benefit from the fact that we are just emerging from a depression in the industry from COVID-19. Fleets haven't grown much at all, in fact they've shrunk meaningfully since before COVID-19, and that at least means that the industry has stayed rational. While things probably can't get worse than they were these last couple of years, they can still get worse from now for reasons more than just a reversal in revenge travel. 17% exposure to passenger airlines poses a risk as consumer wallets are meaningfully pressured by rising rates.

The other more major delta could come from railroads. Some settlements are getting paid by railroad companies to unions since there was conflict over freight salaries in the US. Biden had to step in to avoid a strike that would have been the response to a failed bid by railroad companies to raise wages substantially already by 25% over a few years. There are other agreements that are getting reached over sick leave which hadn't been included in the deal that was essentially forced upon railroad workers that could continue to increase intensity of labor in operating railroads. There is already obvious inflation in compensation for railroads that are not helping income. With pressure on the goods boom in general coming from tightened consumer wallets which are evidenced on the surface by credit card intensity and delinquency, the vaunted industry may go through some declines, even if they're not going to be sharp. Compensation expenses are almost 20% of the company's revenues.

Bottom Line

The earnings quality in a lot of the portfolio is good, but even the most dependable business models in IYT are not immune to a recession and inflation that is already coming into effect. The expense ratio is at 0.39%, and the PE is almost 16x implying a pretty weak earnings yield while growth is no longer apparent. Considering that short term fixed income securities that could help you weather the storm are currently trading with around 6% yields, there really isn't a whole lot of reason to commit funds to IYT while you can still get bargains on the market with yields that can compete better with increasingly compelling short term fixed income securities. IYT is a pass.

Thanks to our global coverage we've ramped up our global macro commentary on our marketplace service here on Seeking Alpha, The Value Lab. We focus on long-only value ideas, where we try to find international mispriced equities and target a portfolio yield of about 4%. We've done really well for ourselves over the last 5 years, but it took getting our hands dirty in international markets. If you are a value-investor, serious about protecting your wealth, us at the Value Lab might be of inspiration. Give our no-strings-attached free trial a try to see if it's for you.