Seeing the Forest Through the Trees

Transcription

1 Credit Suisse Equity Research Americas/United States Seeing the Forest Through the Trees Fresh Thoughts on Transports as Chapter Closes on Freight Recession Increased Conviction in Rails : From a fundamental standpoint, volumes have turned positive after 6 consecutive quarters of decline; and while core pricing has tracked downward with rail inflation, we expect pricing gains to accelerate in 2H17. Considering this in conjunction with improved network efficiency, the rails should demonstrate strong operating leverage as volumes return - contributing to solid EPS growth in While Tax Reform Implications May Be Underappreciated: Although it is well understood that the U.S. rails stand to benefit handsomely from the proposed tax reforms, there has been some debate amongst investors as to whether the immediate expensing of capex will have a neutral or positive impact. We created a quantitative framework to help investors deconstruct the moving parts under different corporate tax rate scenarios (interactive models available upon request). Our analysis suggests that the immediate expensing of capex is a meaningful contributor to FCF and could bring cash tax expenses down into the low-to-mid teens range sustainably. Overall, we see an upwards of 30% increase in FCF relative to our current 2018 estimates. Further, we conclude that NSC is the biggest beneficiary given that it incurred the highest cash tax expense last year (as a % of PTI) and its capex that is elevated relative to its operating cash flow. Updated Views: We have refreshed our subsector rankings and shared updated views on XPO, JBHT, and UPS in this report. We are also providing updated bull and bear theses for each company in our universe. March 6, 2017 RESEARCH ANALYSTS Allison Landry Research Analyst +1 (212) allison.landry@credit-suisse.com Daniel Schuster Research Analyst +1 (212) daniel.schuster@credit-suisse.com Anuj Shah Research Analyst +1 (212) anuj.shah@credit-suisse.com DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES, ANALYST CERTIFICATIONS, LEGAL ENTITY DISCLOSURE AND THE STATUS OF NON-US ANALYSTS. US Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.

2 Investment Summary We have refreshed our views on the Transport sector, the highlight of which is a comprehensive analysis of the implications of proposed tax reform on the major U.S. Rails. Our conclusions are as follows Increased Conviction in Railroads : From a fundamental standpoint, volumes have turned positive after 6 consecutive quarters of decline; and while core pricing has tracked downward with rail inflation, we expect pricing gains to accelerate in 2H17. Considering this in conjunction with improved network efficiency, the rails should demonstrate strong operating leverage as volumes return - contributing to solid EPS growth in Further, as we argued in our July '16 note Deflating the Rail Capex Balloon, the multi-year period of elevated capex had peaked - positioning the Class I's to generate the strongest FCF in years. While Tax Reform Implications May Be Underappreciated for U.S. Rails: Although it is well understood that the U.S. rails stand to benefit handsomely from the proposed tax reforms (given their relatively high effective tax rates; significant capital spending; and large deferred tax liabilities), there has been some debate amongst investors as to whether the immediate expensing of capex will have a neutral or positive impact on cash flow. Further, we think the reduction in cash taxes is sustainable (and not just a tax payment timing difference), given that capital spending levels are relatively permanent as ~70% of capex is allocated towards maintenance expenditures. Accordingly, we believe that the market may be underestimating the contribution of the immediate expensing of capex. We created a quantitative framework for CSX, NSC and UNP to help investors deconstruct the moving parts under different corporate tax rate scenarios. Our initial analysis (which is based on a number of assumptions given the uncertainty surrounding how tax reform will ultimately unfolds) suggests that the immediate expensing of capex is a meaningful contributor to FCF; with NSC, CSX and UNP seeing an upwards of 30% increase in FCF relative to our current 2018 estimates. Further, we conclude that NSC is the biggest beneficiary given that it incurred the highest cash tax expense last year (as a % of PTI) and its capex that is elevated relative to its operating cash flow. Truckload Not Out of the Woods Yet: Oversupply continues to plague the Truckload sector, while the industry eagerly awaits an expected reduction in capacity once the ELD mandate is implemented in December Correspondingly, the bid season is not expected to yield much in the way of rate increases; while at the same time the truckers continue to face headwinds from increasing driver pay. Further, recent demand softness cited by some of the large public carriers has contributed to a downdraft in spot rates. Supporting this is recent commentary from some brokers that net revenue margins have expanded thus far in Q1. Key Debate in Eastern Rails - NSC Risk/Reward Currently Screens as More Attractive: While we have no doubt in Hunter Harrison's capabilities to right the ship at CSX, at current prices, NSC appears more attractive on a risk/reward basis - and in our view, represents an opportunity for investors who missed the doubling of shares in CSX. Indeed, NSC s 5-year plan is not nearly as robust as what we believe would occur at CSX under Hunter Harrison; but is conservative and leaves room for upside and EPS beats. Although we would not argue that NS could see the same pace of margin improvement, should management consistently execute and at least move in the same direction as CSX, investors may be willing to reward the company. What if Tax Reform Falls Apart?: We cannot ignore the potential for the proposed tax reform to simply not happen. If tax reform does not get passed, we would own JBHT given that the stock trades at a roughly 4- turn forward P/E discount to its 5-year historical average even after assuming a lower tax rate. We believe that the significant discount to its historical multiple, which is in part driven by short-term weakness in its Intermodal division, seems overdone. Additionally, we would still own shares of UNP, CSX, and NSC given the positive FCF improvement profile associated with declining capex, which should be sustainable for several years. Finally, we would look to names like CP and FDX that experienced little to no post-election bump and as such may outperform peers if postelection tax reform expectations are unwound. 1

3 Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 Year-over-Year (% Change) Y/Y Chg. Freight Recession Finally Over Freight volumes have improved due to a combination of easy comps and a stabilization in coal volumes North American Rail Volumes 2nd Quarter of Recovery Cass Shipments Index Began Recovering in October % 4.0% 4% 2% 2.0% 0.0% -2.0% -4.0% -6.0% 0% -2% -4% -6% -8.0% -8% -10.0% 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17TD Sources: AAR, Mark Schulberg, CASS Information Systems, Bloomberg 2

4 Bearish Bullish Subsector Rankings Sector Change in View Commentary Rails Higher conviction Volumes have turned positive and pricing should follow. Capex is coming down, and FCF conversion is improving. The incremental cash flow benefit to FCF from tax reform is substantial, particularly for the large US-only rails. Airfreight & Ground Trucking Unchanged, but capital intensity concerning Incrementally More Negative The rapid growth in ecommerce - a trend which UPS recently noted has accelerated is driving a need for significant capex. In other words, volume growth has become more expensive, and we now question whether this is structural in nature. We continue to prefer FDX to UPS. We are incrementally more bearish as supply is coming out at a snail-like pace, and 2017 isn t likely to an impact from the upcoming ELD mandate terms of either bid season pricing or capacity (barring a meaningful change in demand). The stocks screen as expensive even with the recent pullback; though we note that we are keeping a close eye on the group as conditions can change quickly, and the stocks typically move higher fast. 3PLs Unchanged Non-asset based 3PLs tend to underperform during transitions in the freight cycle as net revenue margins come under pressure a key assumption in our models. We currently prefer asset-intensity given the inherent operating leverage embedded in these businesses during upturns in the freight cycle. Sources: Credit Suisse Research 3

5 Incremental Changes in Select Stock Views Stock Rating Updated View What s Changed Outperform Neutral Outperform Outperform Incrementally Positive Incrementally negative Incrementally more conviction Slightly less conviction in the near-term At current prices, NSC appears more attractive on a risk/reward basis - and in our view, represents an opportunity for investors who missed the doubling of shares in CSX. Indeed, NSC s 5-year plan is not nearly as robust as what we believe would occur at CSX under Hunter Harrison; but is conservative and leaves room for upside and EPS beats. Although we would not argue that NS could see the same pace of margin improvement, should management consistently execute and at least move in the same direction as CSX, investors may be willing to reward the company. Capital intensity is increasing due to structural changes in serving ecommerce growth, which points toward lower ROIIC. As such, returns to shareholders are likely to decline over the next few years. Management is establishing a track record of execution. We've written since 3Q15 that multiple re-rating would take several quarters, but our analysis suggests there is significant room for the stock to run further. The truckload market remains loose, likely pressuring intermodal load growth and rates in That said, we remain positive on long-term secular intermodal volume growth trends. Outperform Incrementally more conviction Our sensitivity analysis suggests upside still remains if Hunter Harrison becomes CEO. Sources: Credit Suisse Research, Company Logos 4

6 Deconstructing Tax Reform for the U.S. Rails

7 U.S. Rails Major Beneficiaries of Proposed Tax Reform The large, U.S.-only rails (CSX, NSC, and UNP) are set to be major beneficiaries of proposed corporate tax reform in the U.S. due to lower federal tax rates, the cash flow benefit of immediate expensing of capex, and the balance sheet benefit of reduced deferred tax liabilities. To quantify the potential impact of tax reform, we have leveraged some of the conclusions from our HOLT team s 2/12 note Potential Implications of U.S. Tax Reforms and we have conducted an analysis that attempts to frame the combined impact of lower tax rates, immediate expensing of capex, and the partial offset of losing interest expense deductibility. Investors have expressed a vague sense that 100% capex expensing might be neutral to positive for the rails, but to our knowledge, few of our competitors have attempted to put a quantitative framework around the impact of capex expensing at this point. In a nutshell our framework attempts to model deferred taxes under a 100% capex deductibility scheme and test the sensitivity of FCF (see appendix for details). That said, this is just our first cut at a framework given how much uncertainty there is around this topic, and we welcome clients to use our interactive scenario models (available upon request). Our initial analysis suggests the immediate expensing of capex could cause FCF at the US-only rails to increase even faster than net income. Specifically, under a 20% federal tax rate, we estimate capex expensing would add 15% to our current FCF estimate at CSX, 14% to our current FCF estimate at NSC, and 8% to our current FCF estimate at UNP (though we note that it is not independent of lower tax rates). Overall, cash tax expense could fall into the mid-to-low teens range (as a % of PTI) from the mid-to-upper 20s range (as a % of PTI). We see NSC as the biggest beneficiary of overall tax reform since it paid the highest cash tax rate (27%) in 2016 (indeed, under a 20% federal tax rate, we anticipate that NSC s FCF would be 34% higher than our current forecast). For each rail, our analysis supports the FCF-improvement thesis we outlined in our July '16 note Deflating the Rail Capex Balloon. Further, we think the FCF benefits would be relatively sustainable given that ~70% of rail capex is designated as maintenance, or replacement, capex. Sources: Credit Suisse, HOLT 6

8 U.S. Rails Well Positioned to Benefit from Lower Tax Rate For more information, check out Ron Graziano s 2/12 market commentary: Potential Implications of U.S. Tax Reforms Sources: Credit Suisse HOLT, Factset 7

9 U.S. Rails Also Have Some of Highest Capex in S&P500 For more information, check out Ron Graziano s 2/12 market commentary: Potential Implications of U.S. Tax Reforms Sources: Credit Suisse HOLT, Factset 8

10 % Increase in FCF vs. Current Est. Increase in FCF vs. Current Est. ($m) FCF Thesis on U.S. Rails Bolstered by Tax Reform & Immediate Capex Expensing 40% 35% 30% 25% % Increase in FCF vs CS 18 Estimate (assuming 20% federal tax rate) 30% 34% 24% $1,200 $1,000 $800 $ Increase in FCF vs CS 18 Estimate (assuming a 20% federal tax rate). $1,106 20% 15% 10% 5% $600 $400 $200 $461 $472 0% CSX NSC UNP $0 CSX NSC UNP Our analysis suggests that NSC will be the biggest relative winner from tax reform proposals Sources: Credit Suisse Estimates 9

11 2018 Free Cash Flow ($m) CSX FCF Assuming 20% Federal Tax Rate $2,500 $2,000 $236 $120 $345 $1,500 $1,000 $1,550 CSX's FCF increases 30% vs. our current 2018 estimate $2,010 $500 $0 CS '18 Est. Tax Impact Tax + Depreciation Tax + Depreciation - Interest Shield Note: Components are cumulative and not mutually exclusive Potential '18 FCF Sources: Credit Suisse Estimates 10

12 2018 Free Cash Flow ($m) NSC FCF Assuming 20% Federal Tax Rate $2,500 $2,000 $200 $113 $1,500 $385 $1,000 $1,401 NSC's FCF increases by 34% vs. our current 2018 estimate $1,874 $500 $0 CS '18 Est. Tax Impact Tax + Depreciation Tax + Depreciation - Interest Shield Note: Components are cumulative and not mutually exclusive Potential '18 FCF Sources: Credit Suisse Estimates 11

13 2018 Free Cash Flow ($m) UNP FCF Assuming 20% Federal Tax Rate $7,000 $6,000 $380 $165 $5,000 $892 $4,000 $3,000 $2,000 $4,586 UNP's FCF increases by 24% vs. our current '18 Estimate $5,692 $1,000 $0 CS '18 Est. Tax Impact Tax + Depreciation Tax + Depreciation - Interest Shield Note: Components are cumulative and not mutually exclusive Potential '18 FCF Sources: Credit Suisse Estimates 12

14 Cash Tax Rate % increase vs. current forecast Immediate Expensing of Capex Does Matter Investors may be underappreciating the long-term impact Cash Tax Rate Under Various Federal Tax Rates Increases in FCF and NI Under Various Tax Rates 30% 40% 25% Immediate expensing of capex significantly reduces the cash tax rate for US rails, even if the Federal rate only drops to 25%. 35% 30% 20% 25% 15% 20% 15% 10% 5% 35% 30% 25% 20% 15% 10% 25% 20% 15% Federal Tax Rate Federal tax rate Increase in FCF Increase in net income Under U.S. tax reform proposals, 100% capital expenditures may qualify for immediate expensing against taxable income. Our initial quantitative framework suggests this change could push cash taxes at the U.S.-only rails (CSX, NSC, UNP) down in addition to an outright reduction in the federal tax rate causing cash tax rates to fall even faster than GAAP tax rates and FCF to increase more than GAAP net income. Further, we think the reduction in cash taxes is sustainable (and not just a one-time tax payment timing difference), given that capex levels are relatively permanent considering ~70% of capex is allocated towards maintenance expenditures. We have heard variant views on whether capex expensing would even matter, with bears arguing that that the incremental benefit is not material to cash flow, as the rails have already benefitted from accelerated depreciation over the past decade. As a result of this pushback from investors, we think the incremental FCF benefits may be underappreciated by the market. Sources: Credit Suisse Estimates, Company Data 13

15 Updated Views on Key Topics and Select Stocks

16 The Eastern Debate: CSX vs. NSC Conclusion: We currently prefer shares of NSC to CSX at this time though we maintain our Outperform ratings on both stocks. CSX View: While we believe that Hunter Harrison will be installed at CSX as CEO (with recent news suggesting that a settlement may be reached as early as this week), at the current price our sensitivity analysis through 2019 shows that much of the expected improvement is priced in. That said, as the story unfolds and plans are unveiled, we will have a better sense of the EPS upside, which we admit could be at a low. In particular, we highlight that, based on past discussions with management, much of CSX s network doesn t have sidings that are sufficient to handle 10,000 foot trains compared to other rails that don t require a massive overhaul to this end. As we saw at CP, Hunter Harrison reduced sidings rather quickly. This is just one example of where we think significant costs can come out faster than expected. Thus, we keep our Outperform rating on CSX. NSC View: The question then becomes, does CSX shed traffic during the transition, and if so how much of the service sensitive traffic will NSC be able to capture? This is important, as NSC s network performance is solid and the company is also undergoing a multi-year improvement plan. And incremental traffic gains would come with strong incremental margins. Further, our analysis suggests that even if NSC achieves significantly less impressive O.R.s (in the mid-to-upper 60s range by 2019), there is a more attractive risk/reward profile in NSC shares than if CSX were to reach the low-60s O.R. range in 2 years. Conclusion: To be clear, we are not suggesting that NSC will be able to keep pace with the margin expansion that Hunter Harrison is expected to deliver at CSX should he take the helm in the near future. However, current valuation levels suggest a more attractive risk/reward profile at NSC at this time. Sources: Credit Suisse, Company Logos 15

17 Fwd P/E CSX: Upside Remains, but Improvement Priced In CSX Scenario Analysis Operating Ratio 60% 61% 62% 63% 64% 65% 2019 EPS $3.27 $3.18 $3.08 $2.99 $2.90 $2.81 Upside to current estimate 31% 28% 24% 20% 17% 13% Operating Ratio 60% 61% 62% 63% 64% 65% 15.0x -4% -7% -9% -12% -15% -17% 16.0x 2% -1% -3% -6% -9% -12% 17.0x 9% 6% 3% 0% -3% -6% 18.0x 15% 12% 9% 5% 2% -1% 19.0x 22% 18% 15% 11% 8% 5% Given Hunter Harrison s track record of improving rail operating margins, we anticipate CSX could enter the low-60s O.R. range under Mr. Harrison s leadership by However, we think much of this potential improvement has been priced into the stock. As such, while we think that Hunter Harrison would be able to deliver significant efficiency gains to CSX and that there could eventually be upside to current expectations, we think the risk/reward on the stock is only modestly favorable at this time. [1] We note that the range of multiples is above CSX s historical 5-yr avg. Fwd P/E of 13.5x Sources: Credit Suisse Estimates 16

18 Fwd P/E NSC: Risk Reward Looks More Attractive NSC Scenario Analysis Operating Ratio 64% 65% 66% 67% 68% 69% 2019 EPS $8.58 $8.31 $8.05 $7.78 $7.52 $7.25 Upside to current estimate 9% 5% 2% -1% -5% -8% Operating Ratio 64% 65% 66% 67% 68% 69% 15.0x 1% -2% -5% -8% -11% -15% 16.0x 8% 4% 1% -2% -6% -9% 17.0x 15% 11% 7% 4% 0% -3% 18.0x 21% 18% 14% 10% 6% 3% 19.0x 28% 24% 20% 16% 12% 8% NSC s 5-year plan is not nearly as robust as what we believe would occur at CSX under Hunter Harrison; but is conservative and leaves room for upside and EPS beats. Although we would not argue that NS could see the same pace of margin improvement, should management consistently execute and at least move in the same direction as CSX, investors may still reward the company. Conclusion: NSC appears more attractive on a risk/reward basis at current prices, and is an opportunity for investors who missed the doubling of shares in CSX. [1] We note that the range of multiples is above NSC s historical 5-yr avg. Fwd P/E of 13.3x. Sources: Credit Suisse Estimates 17

19 2018 EBITDA ($m) 2018 EBITDA ($m) Risk Reward is Attractive at XPO Asset-Heavy Peers EV/ Fwd. EBITDA Asset-Light / Non- Asset Peers EV/ Fwd. EBITDA KNX 8.6x CHRW 12.6x SWFT 5.3x ECHO 7.3x WERN 5.4x EXPD 11.8x ARCB 4.6x LSTR 12.0x ODFL 9.4x JBHT 9.7x SAIA 6.8x HUBG 9.4x Average 6.7x Average 10.4x Avg. (ex-knx and ODFL) 5.5x EBITDA mix EV/EBITDA Multiples Asset-heavy 46% Asset-heavy 5.5x Asset-light / non-asset 54% Asset-light / non-asset 10.4x Given its mix of assetheavy vs. asset-light businesses, we think that XPO could trade at ~8x EV/EBITDA compared to the current multiple of ~7x. As such, we see 2:1 upside vs. downside risks in shares. Blended EV/EBITDA Share price in 12 months EV/EBITDA Multiple 7.0x 7.5x 8.0x 8.5x 9.0x 8.2x Share price upside vs. downside EV/EBITDA Multiple 7.0x 7.5x 8.0x 8.5x 9.0x $1,350 $37.21 $42.65 $48.08 $53.52 $58.95 $1,350-28% -17% -7% 4% 14% $1,425 $41.44 $47.18 $52.91 $58.65 $64.39 $1,425-20% -9% 3% 14% 25% $1,500 $45.67 $51.71 $57.74 $63.78 $69.82 $1,500-11% 0% 12% 24% 35% $1,575 $49.89 $56.23 $62.57 $68.92 $75.26 $1,575-3% 9% 21% 34% 46% $1,650 $54.12 $60.76 $67.41 $74.05 $80.69 $1,650 5% 18% 31% 44% 56% Sources: Credit Suisse, Thomson One 18

20 E 2018E 2019E % of adj. net income Capex as a % of sales Returns at UPS are Headed Lower We continue to believe that shares are fairly valued, and thus maintain our Neutral rating on the stock. While we acknowledge that the investments UPS is making will likely serve it well over the long term as it expands capacity and improves efficiency to handle impending growth, we expect the meaningful step-up in capex to reduce FCF. Consequently, returns to shareholders will likely be scaled back over the next 3 years; indeed our analysis suggests that returns to shareholders as a % of net income will fall to 78% on average in vs. the prior 10 year average of 107%. We also point out that UPS omitted its prior target of distributing 100% of net income to shareholders. 250% 200% 15% 12% 150% 100% 50% 0% -50% 9% 6% 3% 0% -3% -100% -6% Dividends as % of adj. NI FCF conversion Share repo as % of adj. NI Capex (% of sales) Sources: Credit Suisse Estimates, Company Data 19

21 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 JBHT: Long-Term Thesis Holds, but 17 Pricing Env t Stiff We continue to believe that J.B. Hunt will generate sustainable intermodal load growth over the long-term. Currently, truckload spot prices have weakened in January and February and prices aren t expected to be positive in 1H17. While rates are expected to turn positive in 2H17, the jury is still out. We anticipate this will put pressure on intermodal rates this year. As such, while we still have confidence in our long-term thesis on long-term intermodal growth, the environment in 2017 may present challenges. $2.50 $2.40 $2.30 $2.20 $2.10 $2.00 $1.90 $1.80 $1.70 $1.60 Truckload Average Rate Per Mile $1.50 Sources: Credit Suisse, Truckstop.com, Bloomberg 20

22 Target Prices Changes Previous Target Price New Target Price %Upside / Downside CHRW $71 $75-7% CNI $70 $72 1% CP $162 $168 14% CSX $41 $54 11% ECHO $25 $25 17% EXPD $52 $53-7% FDX $205 $209 7% GWR $80 $85 15% JBHT $102 $107 9% KNX $31 $32-1% KSU $84 $86-4% LSTR $82 $83-5% NSC $128 $136 12% ODFL $92 $96 4% UNP $118 $124 14% UPS $109 $111 5% WERN $27 $28 1% XPO $63 $64 25% Sources: Credit Suisse Estimates 21

23 Appendix

24 Implied Tax Reform EPS Impact and Valuation Analysis In this analysis, we derived an implied forward P/E multiple based on a rough calculation of 2018 EPS under a lower tax rate (20% US Federal tax rate). We find that the average implied P/E multiple is still below the historical average for the majority of our coverage universe. Sub- Sector Ticker Current Forward P/E (2018E) Implied Fwd P/E under lower tax rate (2018E) 5-Yr Fwd P/E Avg Rails CNI 18.3x 16.3x 16.4x -0.1x Comments CP 15.4x 13.7x 17.1x -3.4x Departure of Hunter Harrison, top-line uncertainty may be driving bearishness. CSX 21.8x 17.6x 13.7x 3.9x Expectations that Hunter Harrison may take over have elevated the multiple. KSU 16.0x 14.2x 19.4x -5.2x Cocerns on potential damage to U.S. - Mexico trade serve as major overhang. NSC 17.2x 13.9x 13.5x 0.4x Knock-on benefits of Hunter Harrison joining CSX have helped shares. UNP 16.8x 13.5x 14.9x -1.4x GWR 20.4x 15.9x 16.7x -0.9x Much of the company's revenues come from Europe and Australia. Trucking JBHT 20.1x 16.2x 19.9x -3.7x Intermodal rates have fallen and margin cocerns are weighing. KNX 24.1x 19.4x 18.2x 1.1x Trucking may be seen as early-cycle trade and major tax reform beneficiaries. WERN 20.4x 16.4x 15.2x 1.1x Trucking may be seen as early-cycle trade and major tax reform beneficiaries. ODFL 20.7x 16.6x 15.9x 0.7x Trucking may be seen as early-cycle trade and major tax reform beneficiaries. Airfreight/ FDX 14.6x 12.6x 13.1x -0.5x Trade uncertainty, TNTE integration risk may be impacting shares. Ground UPS 16.4x 13.3x 15.9x -2.5x Higher capex, lower returns, and trade uncertainty may be impacting shares. 3PLs CHRW 20.3x 16.4x 18.6x -2.2x Non-asset companies may be out of favor in freight recovery years. EXPD 21.4x 17.2x 19.7x -2.6x Non-asset companies may be out of favor in freight recovery years. ECHO 19.5x 15.7x 20.3x -4.6x There is risk to long-term guidance. LSTR 22.8x 18.4x 18.2x 0.1x Average 19.2x 15.7x 16.9x -1.1x S&P x 14.5x Variance vs. 5-Yr Fwd. P/E Avg Source: Thomson Eikon, Credit Suisse Research 23

25 CSX Tax Reform FCF Impact/Math **** INTERACTIVE MODEL AVAILABLE UPON REQUEST Lower Federal Tax Rate Lower Tax Rate + Immediate Capex Expensing Lower Tax Rate + Immediate Capex Expensing + Interest Shield 2016 Actuals CS 2018 Est. Income statement (GAAP) Book (GAAP) depreciation 1,301 1,362 1,362 1,362 1,362 Net interest expense Book Pre-Tax Income (GAAP) 2,741 3,229 3,229 3,229 3,229 Effective tax rate 37.5% 37.5% 22.5% 22.5% 22.5% x Book (GAAP) Taxes 1,027 1, = Net Income (GAAP) 1,714 2,018 2,502 2,502 2,502 Difference vs. current system 24% 24% 24% Cash flow statement - Deferred Taxes Interest tax shield removal (120) + Book (GAAP) Taxes 1,027 1, Cash Taxes Cash tax rate (% of GAAP pre-tax income) 23% 27% 16% 9% 12% Deferred Taxes / Effective tax rate 37.5% 37.5% 22.5% 22.5% 22.5% = Implied additional depreciation exp. in taxable PTI (tax-basis less book-basis 1, ,982 1,982 % of capex 45% 44% 44% 94% 94% Components of additional depreciation exp. in taxable PTI Additional deductible depreciation expense from current year capex (tax basis) 1,199 1,050 1,050 2,100 2,100 % of capex 50% 50% 50% 100% 100% Additional deductible depreciation expense from existing asset base (tax basis) % of capex -5% -6% -6% -6% -6% FCF buildup Net Income (GAAP) 1,714 2,018 2,502 2,502 2,502 + Book (GAAP) depreciation Deferred Taxes Interest tax shield removal (120) - Working capital & other (379) (80) (80) (80) (80) = Operating cash flow 3,041 3,650 3,994 4,230 4,110 - Capex 2,398 2,100 2,100 2,100 2,100 = Free cash flow 643 1,550 1,894 2,130 2,010 Cumulative difference vs. current system 0% 0% 22% 37% 30% Individual component differences 22% 15% -8% Sources: Credit Suisse, Company Data 24

26 NSC Tax Reform FCF Table/Math **** INTERACTIVE MODEL AVAILABLE UPON REQUEST Lower Federal Tax Rate Lower Tax Rate + Immediate Capex Expensing Lower Tax Rate + Immediate Capex Expensing + Interest Shield 2016 Actuals CS 2018 Est. Income statement (GAAP) Book (GAAP) depreciation 1,026 1,097 1,097 1,097 1,097 Net interest expense Book Pre-Tax Income (GAAP) 2,582 3,174 3,174 3,174 3,174 Effective tax rate 35.4% 37.0% 22.0% 22.0% 22.0% x Book (GAAP) Taxes 914 1, = Net Income (GAAP) 1,668 2,000 2,476 2,476 2,476 Difference vs. current system 0 24% 24% 24% Cash flow statement - Deferred Taxes Interest tax shield removal (113) + Book (GAAP) Taxes 914 1, Cash Taxes Cash tax rate (% of GAAP pre-tax income) 27% 30% 18% 11% 15% Deferred Taxes / Effective tax rate 35.4% 37.0% 22.0% 22.0% 22.0% = Implied additional depreciation exp. in taxable PTI (tax-basis less book-basis ,518 1,518 % of capex 34% 33% 33% 83% 83% Components of additional depreciation exp. in taxable PTI Additional deductible depreciation expense from current year capex (tax basis) ,820 1,820 % of capex 50% 50% 50% 100% 100% Additional deductible depreciation expense from existing asset base (tax basis) % of capex -16% -17% -17% -17% -17% FCF buildup Net Income (GAAP) 1,668 2,000 2,476 2,476 2,476 + Book (GAAP) depreciation Deferred Taxes Interest tax shield removal (113) - Working capital & other 113 (100) (100) (100) (100) = Operating cash flow 3,034 3,221 3,606 3,807 3,694 - Capex 1,887 1,820 1,820 1,820 1,820 = Free cash flow 1,147 1,401 1,786 1,987 1,874 Cumulative difference vs. current system 0% 0% 27% 42% 34% Individual component differences 27% 14% -8% Sources: Credit Suisse, Company Data 25

27 UNP Tax Reform FCF Table/Math **** INTERACTIVE MODEL AVAILABLE UPON REQUEST Lower Federal Tax Rate Lower Tax Rate + Immediate Capex Expensing Lower Tax Rate + Immediate Capex Expensing + Interest Shield 2016 Actuals CS 2018 Est. Income statement (GAAP) Book (GAAP) depreciation 2,038 2,183 2,183 2,183 2,183 Net interest expense Book Pre-Tax Income (GAAP) 6,766 8,061 8,061 8,061 8,061 Effective tax rate 37.4% 38.0% 23.0% 23.0% 23.0% x Book (GAAP) Taxes 2,533 3,063 1,854 1,854 1,854 = Net Income (GAAP) 4,233 4,998 6,207 6,207 6,207 Difference vs. current system 0 24% 24% 24% Cash flow statement - Deferred Taxes Interest tax shield removal (165) + Book (GAAP) Taxes 2,533 3,063 1,854 1,854 1,854 Cash Taxes 1,702 2,259 1, ,152 Cash tax rate (% of GAAP pre-tax income) 25% 28% 17% 12% 14% Deferred Taxes / Effective tax rate 37.4% 38.0% 23.0% 23.0% 23.0% = Implied additional depreciation exp. in taxable PTI (tax-basis less book-basis 2,220 2,117 2,117 3,767 3,767 % of capex 63% 64% 64% 114% 114% Components of additional depreciation exp. in taxable PTI Additional deductible depreciation expense from current year capex (tax basis) 1,753 1,650 1,650 3,300 3,300 % of capex 50% 50% 50% 100% 100% Additional deductible depreciation expense from existing asset base (tax basis) % of capex 13% 14% 14% 14% 14% FCF buildup Net Income (GAAP) 4,233 4,998 6,207 6,207 6,207 + Book (GAAP) depreciation Deferred Taxes Interest tax shield removal (165) - Working capital & other 423 (100) (100) (100) (100) = Operating cash flow 7,525 7,886 8,777 9,157 8,992 - Capex 3,505 3,300 3,300 3,300 3,300 = Free cash flow 4,020 4,586 5,477 5,857 5,692 Cumulative difference vs. current system -12% 0% 19% 28% 24% Individual component differences 19% 8% -4% Sources: Credit Suisse, Company Data 26

28 Rails: Bull versus Bear Ticker Bull Case Bear Case CS View CNI High quality rail that general outpaces industry in terms of volume growth and has best-in-class operating margins. Healthy FCF despite relatively elevated capex. Room to expand leverage. Volume growth may slow in the back half of Margin degradation may occur in 2017 for the first time in the past 4 years. The company trades at a premium valuation versus other rails. Margin upside limited. CNI continues to be a very high quality rail given its demonstrated ability to consistently outgrow the industry over time, outstanding O.R., solid FCF profile, and low leverage. That said, we see better opportunities elsewhere in the rails. CP CP will continue to drive O.R. improvement in Still opportunity to convert truckloads to intermodal and increase merchandise market share with improved service. Aggressive on buybacks. The most highly regarded CEO in the industry (Hunter Harrison) departed in January There are concerns that while the management team is excellent at network efficiency, the company will not be able to grow volumes as fast as peers. CP will likely continue to improve its O.R. while simultaneously improving service. Buybacks are accretive to its EPS growth. With its valuation having fallen below its Canadian peer and relatively conservative 2017 EPS guidance of 7% to 9% growth, we see an opportunity in CP shares. CSX The most highly regarded CEO in the industry (Hunter Harrison) may join the company 17, setting up substantial cost reductions and margin expansion. Coal volumes may actually stabilize in 2017 and beyond. Continued opportunity to grow intermodal over time. If he joins, Mr. Harrison may not be able to drive the margin expansion that investors expect given differences in Eastern US rail networks vs. Canadian rail networks. The company still has outsized exposure to coal, which could drag on overall volume and earnings growth, and keep a lid on margin expansion. We think that Mr. Harrison would be capable of driving the O.R. into the low-60s range, which we think would leave additional upside to shares. This would be a multi-year cost story as it has been at other companies Mr. Harrison has entered. Further, CSX stands to benefit from reduced capex and increased FCF in KSU KSU has secular growth opportunities in x-border Mexico intermodal, automotive, grain, and energy. The company s growth premium vs. other rails has contracted significantly, presenting an opportunity. At least 40% of the company s revenues move either cross border or via interchange across Mexico, which face severe risk if U.S. trade policy reduces trade between the U.S. and Mexico. The company has faced sporadic operating issues. While 4Q17 Mexico volume growth of 4% and management's 2017 commodity outlook are encouraging, the company has yet to post consistent growth in its strategic growth areas or stable cost performance. Trade policy uncertainty will likely continue to create an overhang for shares. NSC NSC has been executing on its long-term targets. The potential CEO transition at competitor CSX could add pressure for management to speed up the implementation of its targets, and could create additional volume opportunities as CSX restructures. Although NSC may continue to work towards a 65% O.R. in 2017, its progress will simply be slower than its peer CSX, which could lead to shareholder pressure and potentially induce activism. Coal continues to present a long-term headwind. NSC is likely to improve its O.R. further as the company betters its service levels and reduces its cost base, creating healthy incremental margins. Given its improved FCF generation profile and the potential knock-on benefits of new management initiatives at its peer CSX, we see an opportunity in NSC shares. UNP Volumes are improving, and core pricing should follow this higher. Incremental margins should be excellent given the strength of UNP s network. The nascent recovery in coal could turn sour, dragging volumes with it. Core pricing could be below cost inflation in UNP has historically generated solid incremental margins in volume recovery years. Given the decrease in capex and positive exposure to tax reform, UNP is set up to generate outstanding FCF conversion in GWR Only rail with secular M&A growth potential with levers to growth on three continents. A stronger commodity environment is expected to support volume growth in all regions in Issues with continental European business should be resolved this year. If the commodity environment loses momentum, earnings guidance of a 1% to 4% y/y decline (ex-short Line Tax Credit) could be further at risk. Company is still working down leverage after multiple acquisitions in 2H16. There is potential upside if commodity strength, truck pricing, or diesel prices surprise favorably, though earnings growth could be at risk if stronger demand fails to materialize. The company is positively exposed to potential infrastructure policies and tax reform, and continues to actively utilize M&A as a lever for growth. Source: Credit Suisse Research 27

29 Logistics: Bull versus Bear Ticker Bull Case Bear Case CS View CHRW Net revenue margins may recover this year if the spot truckload pricing market improves. Company continues to generate healthy FCF given assetlight nature. Company would benefit from a lower tax rate. The company will likely continue to face net revenue margin headwinds in 1H17. Productivity per head could decline. Longer term, competitors are threatening CHRW s share. Pricing transparency also presents threat to margins. A more balanced trucking environment would not be supportive of margin strength, and even if spot pricing increases, it has historically taken a few quarters for this to show up in results. Structurally, the barrier to entry for smaller players has diminished as technology has spread throughout the industry. ECHO Revenue synergies with Command will help ECHO generate above-market growth in The company can grow top line organically and via M&A. There is still room to expand productivity per employee. Brokers could face continued net revenue margin headwinds in Command revenue synergies may end up below the $200m to $300m target. The company expects to update its 2018 revenue and EBITDA targets in the summer of 2017, and management has cautioned that it would need help from markets and additional M&A to meet targets. Command synergies are increasing ECHO's lane density and scale, enabling the company to grow market share and buy capacity more efficiently. The expanded geographic footprint drives increased wallet share with existing customers, and generates opportunities for cross-selling synergies between spot TL, LTL, and managed transportation. The company can drive further growth through additional acquisitions. EXPD Respected management team that has established a top 7 position in the global forwarding space with unique incentive model and in-house technology. Unprecedented rate volatility could continue to put pressure on net revenue margins. Long term, there is concern that new entrants (startups, large e- commerce players) may compete with forwarders. We expect the company's operating leverage be remain constrained in 2017 as challenging net revenue margins and higher headcount weighs on productivity. That said, the airfreight and ocean volume environment are supportive of volume growth in 17. LSTR Production growth from new agents continues to support organic revenue growth in LSTR s unique non-asset model. Company can continue to grow EPS via share buybacks given solid FCF generation and lack of existing leverage. High flatbed presence means the company is exposed to potential weakness in industrial and construction markets. Although its outlook for the freight environment has improved, LSTR will face extra costs in 2017 that could make it difficult to improve the O.R. Indeed, LSTR may incur between $0m and $3m of incremental expenses related to its technology improvement initiative, higher depreciation expense (despite a reduction in company trailer count), and could pay out $7m of bonus payments (which might be higher if it hits additional targets in 2017). XPO XPO continues to build a multi-pronged logistics platform on two continents that can serve as a one-stop shop for customers, with exposure to e-commerce growth. Merger synergies and selfhelp opportunities still achievable after multiple transformative acquisitions. The company is set up for a FCF inflection in 2017 and If the macro environment softens in the US or Europe, or if the cost improvement process loses momentum, XPO s FCF could end up below expectations. M&A appears to be off the table for the near future, which was previously a key part of the story. Company has significant leverage to wind down. XPO continues to deliver on its targets for EBITDA and FCF, which is derisking the stock and moving the valuation towards a multiple that is more consistent with its peer group. Our scenario analysis suggests upside to shares if the company continues on track towards its 2018 EBITDA target. That said, XPO's balance sheet is still relatively levered and poses risk if the macro environment in the US or Europe soften or if its cost initiatives lose steam. Source: Credit Suisse Research 28

30 Trucking / Intermodal: Bull versus Bear Ticker Bull Case Bear Case CS View JBHT Multiple growth levers in intermodal can support double-digit EPS growth. Asset-light business model and superior asset utilization generates healthy returns and FCF. The company continues to have a unique arrangement with its Western rail partner. Continued weakness in fuel prices reduces the incentive to adopt intermodal. A weak truckload environment may keep intermodal pricing in check in A combination of secular growth opportunities in JBHT's intermodal business (60% of consolidated EBIT) positions the company to generate sustainable volume growth longer term. JBHT has the potential to increase participation in the x-border Canada arena with CNI as a partner and the possibility of generating x-border Mexico growth with KSU as a partner. KNX Spot pricing in the truckload market may improve later in 2017 as supply has receded. The full implementation of electronic logging devices in late 17 may further reduce supply. KNX continues to have an industry-leading margin, growing logistics business, track record of successfully growing via M&A. Truckload pricing improvements may fail to materialize, resulting in pricing below wage and other inflation. High expectations for the impact of ELDs in late 2017 and 2018 may not be realized. While corporate tax rates may decline, these benefits may be competed away by a highly fragmented marketplace. With its relative exposure to in irregular lanes, the company could benefit faster than peers from an uptick in the spot environment. However, given a balanced capacity backdrop and a subdued rate environment, in addition to some cost headwinds in 1H17 (e.g. weak used truck market), we anticipate that KNX may struggle to generate earnings growth this year. We are cautious on the benefits of electronic logging devices later this year. ODFL ODFL continues to be an industry-leading LTL. As it grows, network density increases. The company can generate 25%-30% incremental margins over the long-term. If industrial production picks up or if truckload supply becomes scarce, the LTL market could benefit from overflow volumes. ODFL could suffer from any industry-wide irrational pricing if volume growth in the industriallyconcentrated LTL continues to deteriorate - a phenomenon which was last experienced in ODFL s virtuous operating philosophy of leading on technology, creating operational innovations, maintaining high service levels, and generating price increases enable the company to reinvest in the business over time. In spite of any near-term dislocations, the company remains a high-quality long-term growth name. WERN WERN wisely waited to renew contract rates until a more favorable time presented itself in Spot pricing in the truckload market may improve later in 2017 as supply has receded. The company can also continue to grow its non-asset business. Capex is set to come down substantially in 2017, boosting FCF. Truckload pricing improvements may fail to materialize, resulting in pricing below wage and other inflation. High expectations for the impact of ELDs in late 2017 and 2018 may not be realized. While corporate tax rates may decline, these benefits may be competed away by a highly fragmented marketplace. Demand in early 2017 was lighter than normal, pricing gains have yet to materialize, and the used truck market is expected to remain weak which we think may make it difficult to sustain momentum in 1H17. We are cautious on the benefits of electronic logging devices later this year. Source: Credit Suisse Research 29

31 Airfreight / Ground: Bull versus Bear Ticker Bull Case Bear Case CS View FDX The company's capital efficiency is improving as it shifts capex into its higher-margin Ground segment. The completion of SmartPost integration should improve delivery density which is key to serving B2C growth. TNTE integration presents opportunity to generate earnings growth. Ground margins may be restrained through 3Q17. ecommerce growth may necessitate further investments and dilute returns. TNT integration costs could take longer than expected, delaying accretion. Longer term, there is concern about large ecommerce players building their own parcel delivery network. We continue to expect overall capex to trend down as a percentage of sales over the next two years while more capex is placed into the higher ROIC Ground network, improving the company's FCF conversion profile. We also expect FDX to successfully execute on TNT synergies and for the acquisition to be accretive in FY18. UPS UPS is exposed to secular growth in ecommerce volumes. The company has demonstrated its ability to handle peak season volumes. Disciplined management culture. Investments that the company is making to automate its network today will deliver solid returns. The shift to ecommerce has accelerated, and is necessitating greater investment than previously anticipated. The returns on this business may be lower than traditional B2B volumes. A smaller portion of UPS facilities are automated compared to FDX. Longer term, there is concern about large ecommerce players building their own parcel delivery network. While we acknowledge that the investments UPS is making will likely serve it well over the long term as it expands capacity and improves efficiency to handle impending growth, we expect the meaningful step-up in capex to reduce FCF. Consequently, returns to shareholders will likely be scaled back over the next 3 years. We also point out that UPS omitted its prior target of distributing 100% of net income to shareholders. Source: Credit Suisse Research 30

32 Debated Themes for 2017 Macro Rails Trucking 3PLs Commodities Consumer Automotive Intermodal Fuel M&A Airfreight & Ground Commentary Coal volumes have stabilized and could grow at certain rails in A bumper grain crop will continue to be moved through 3Q17. ecommerce growth continues to support volume growth for certain 3PLs and for parcel companies. Auto production may be flat to down 1% in 2017 as demand has flattened and there is an inventory overhang. Intermodal remains a long term secular tailwind for the rails, although near-term headwinds (trucking capacity; low fuel; retail inventories) are exerting downward pressure on volume. Rising fuel prices could create a modest fuel lag headwind in 2017, although fuel surcharges at certain rails may go back into the money. M&A is a relatively quiet theme at present. Tax Reform Regulation Pricing Global trade ecommerce Transportation companies currently have some of the highest effective tax rates among all industries; certain companies would benefit from the immediate expensing of capex. Electronic On-Board Recorder (EOBR) mandate could take capacity out of truck market in late 2017 and into Rail pricing should recover this year as volumes increase and inflation recovers. Truckload pricing expectations are subdued. Weak truckload pricing would be a challenge for 3PLs. Global trade via Airfreight and Ocean is recovering; although US trade policy uncertainty poses a risk. ecommerce continues to grow, but continues to necessitate elevated investment from Ground carriers. Last mile logistics providers benefit from outsize growth. Sources: Credit Suisse Research 31

33 Y/Y change Fw.d P/E Stocks Tend to Do Well in EPS Recovery Years Rails stocks increased by ~25% on average in the two prior EPS recovery years 50% 40% 30% 20% 10% 0% -10% -20% -30% -40% 18x 16x 14x 12x 10x 8x 6x 4x 2x 0x Forecast EPS growth (avg.) Share price chg. (avg.) Actual EPS growth (avg.) Forward P/E (avg.) - beginning Source: Thomson Eikon, Credit Suisse Research 32

34 Companies Mentioned (Price as of 03-Mar-2017) CH Robinson (CHRW.OQ, $79.77) CSX Corporation (CSX.OQ, $49.48) Canadian National (CNI.N, $72.01) Canadian Pacific Railways (CP.N, $149.18) Echo Global Logistics (ECHO.OQ, $21.1) Expeditors International of Washington (EXPD.OQ, $56.5) FedEx Corporation (FDX.N, $194.35) Genesee & Wyoming, Inc. (GWR.N, $73.92) JB Hunt Transport Services (JBHT.OQ, $97.85) Kansas City Southern (KSU.N, $89.5) Knight Transportation (KNX.N, $32.55) Landstar System Inc. (LSTR.OQ, $87.25) Norfolk Southern (NSC.N, $122.4) Old Dominion Freight Line (ODFL.OQ, $91.31) Union Pacific (UNP.N, $109.02) United Parcel Service Inc. (UPS.N, $105.93) Werner Enterprises, Inc. (WERN.OQ, $27.45) XPO Logistics, Inc. (XPO.N, $52.11) Analyst Certification Disclosure Appendix I, Allison M. Landry, certify that (1) the views expressed in this report accurately reflect my personal views about all of the subject companies and securities and (2) no part of my compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this report. The analyst(s) responsible for preparing this research report received Compensation that is based upon various factors including Credit Suisse's total revenues, a portion of which are generated by Credit Suisse's investment banking activities As of December 10, 2012 Analysts stock rating are defined as follows: Outperform (O) : The stock s total return is expected to outperform the relevant benchmark* over the next 12 months. Neutral (N) : The stock s total return is expected to be in line with the relevant benchmark* over the next 12 months. 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Individuals receiving this report from a Canadian investment dealer that is not affiliated with Credit Suisse should be advised that this report may not contain regulatory disclosures the non-affiliated Canadian investment dealer would be required to make if this were its own report. For Credit Suisse Securities (Canada), Inc.'s policies and procedures regarding the dissemination of equity research, please visit Credit Suisse has acted as lead manager or syndicate member in a public offering of securities for the subject company (ECHO.OQ, CSX.OQ, CP.N, XPO.N, UNP.N) within the past 3 years. Principal is not guaranteed in the case of equities because equity prices are variable. Commission is the commission rate or the amount agreed with a customer when setting up an account or at any time after that. This research report is authored by: Credit Suisse Securities (USA) LLC... Allison M. 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