Are Gas Prices Hurting Transport Stocks?

You've probably noticed high prices for gasoline taking a bigger chunk out of your wallet at the pump lately. As an investor, you might wonder how those high fuel prices are affecting some of the stocks in your portfolio. To provide some answers, we took a close look at the companies we cover in the transportation sector to see how the increased cost of fuel trickles down to their bottom lines.

But first, you may also be wondering where the price of gas will go from here. Our oil and gas analysts agree that the recent spike in fuel prices does not seem warranted. Although speculators seem ready for the price of a barrel of oil to keep rising, no shortage exists today. Our analysts also point out that in inflation-adjusted terms, oil costs half what it did at the peak of the oil embargo in the 1970s.

We found that overall, fluctuations in fuel prices do not have a profound effect on the profits of transportation companies, least of all over the long term. Companies that require fuel to deliver their product or service will need to pay for fuel whether it's cheap or expensive. Most transport companies pass the extra cost of fuel on to their customers, although it may take several weeks for them to succeed in doing so. We would only expect a sharp rise in fuel prices to harm the long-term prospects or viability of the most financially strapped and uncompetitive operators in our coverage universe.

In this week's Stock Strategist, we'll visit each industry in the transportation sector and note how fuel prices affect companies to varying degrees, even within the same industry. We start with the airline industry, in which fuel makes up the largest portion of costs (10% to 15% of total expenses on average), and conclude with some logistics providers, which don't buy fuel at all.

Airlines
A fully loaded 737 aircraft holds 6,875 gallons of jet fuel before takeoff. At today's prices (using the Gulf coast spot price of $1.05 per gallon), and assuming a full load of 132 passengers, that means at least $55 of your one-way ticket goes to fill up the tank.

Because airlines compete with one another on almost all of the routes they fly, they have little power to raise prices in response high fuel costs. Consequently, increases in fuel prices generally come out of company profits. While most of the companies we cover will not have their business model or future viability threatened by this reduction in profits, the two most inefficient airlines,  Delta Air Lines  (DAL) and US Airways Group  , which have already lost billions of dollars over the last few years, may be forced into bankruptcy by any prolonged runup in fuel costs.

On the other hand, several airlines, including low-cost  Southwest Airlines  (LUV),  JetBlue Airways  (JBLU), and  AirTran Holdings   are profitable enough and have growth plans steady enough for them to plan their fuel expenditures in advance. Because a futures market for aviation fuel does not exist, these airlines use options on commodities that trade in the same direction as jet fuel (namely heating oil and crude) to lock in good prices well in advance. Exemplary in this regard, Southwest has used this hedging technique to cap the price it will pay for 80% of its fuel needs into the early part of 2006. In 2004, the most Southwest will pay for 80% of its fuel is the equivalent of $24 per barrel, well below recent trading prices of $41 per barrel of oil.

Trucking
Long-haul trucking firms also typically have fuel costs that comprise 10% to 15% of their total costs. The most common way in which large trucking firms deal with increases in their fuel costs is to pass them along to customers. Some have formalized fuel surcharges, which they update weekly, and others use a less formal mechanism, but the idea is the same: Charge a prearranged amount for the service, and add a fuel surcharge that can vary with the price of fuel.

The biggest fuel-related risk for large trucking firms, such as  JB Hunt Transport Services (JBHT),  Swift Transportation  , and  Werner Enterprises  (WERN), is that the price of fuel may increase significantly in less time than it takes them to pass new surcharges on to customers. Nonetheless, most firms have the opportunity to adjust their surcharges within days or weeks of a move in the price of fuel. Smaller trucking outfits and independent contractors, on the other hand, are often paid a flat fee to drive cargo, and increased fuel costs therefore hit their bottom line directly.

Delivery & Logistics
We cover a wide variety of firms in this arena. The biggest and most familiar names are  United Parcel Service (UPS) and  FedEx (FDX). Over the last three years, fuel represented about 3.6% of costs for UPS and 6% for FedEx. They each pass fuel costs on to customers in the form of surcharges, usually billed to their bigger customers. Earlier this year, UPS changed the way it recovers increased fuel costs from customers. Rather than charging a per-package charge, UPS now places a monthly surcharge on regular customers' bills. The surcharge is indexed to the price of jet fuel, not diesel, because the company's planes burn far more fuel per package than its delivery vans do.

Asset-free logistics firms, such as  Expeditors International  (EXPD) and  CH Robinson Worldwide (CHRW), don't own any vehicles, so they don't pay for fuel directly. As customers of some of the companies named above, however, these firms do pay the fuel surcharges, and they pass them on to their clients, in turn.

You may have detected a pattern here. One of the reasons the prospect of sustained increases in oil prices spook the market is not that the profits of transportation companies may suffer, but rather because these costs are ultimately passed along to consumers in the form of higher prices for the goods delivered by those companies. Consumers generally pay the price for higher fuel costs--and not just at the pump.