Truckers of the Bullish Kind

Jarrod is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The transport sector, savaged throught the Global Financial Crisis (GFC), has since recovered. After climbing back to its 2008 levels at the end of 2010, it essentially tracked sideways for two years. Is 2013 the year that the transport sector makes up for lost time? Take a look at this chart of the iShares Dow Jones Transport Average ETF (NYSEMKT: IYT).

<img src="/media/images/user_16314/iyt_large.JPG" />
 

The iShares Transport Average now looks to be pushing new highs, arguably beginning a new bullish leg upward.

With this in mind, I am asking, "How can I best take advantage of this long term bullish breakout?"

Three stocks have popped up on my radar as potential targets.

Cummins (NYSE: CMI) is a world class leader in the design and production of a suite of transport equipment including trucks, buses, light vehicles, and heavy industry equipment. Cummins is a company with a long-held reputation for innovation, particularly within the engine and generator space.

Some of the attractive financial metrics include:

  • A dividend of 1.8% (funded from just 21% of its earnings)
  • Modest forward PE of 11.2
  • An impressive return on equity of 27% and
  • Just $775 million of debt – exceptionally low for a company with a market cap of $22 billion.

With global growth modest but still growing, Cummins is well positioned to break out. In addition to this, Cummins is in a prime position to benefit from additional business in a cost-conscious market. Businesses know they need to invest and spend on equipment, they just want to do it efficiently. Looking forward, Cummins is positioned to get this business.

My second potential target is Caterpillar (NYSE: CAT). Caterpillar has struggled with concerns over global growth and essentially tracked sideways for two years. Fear after fear of a global downturn appears to be dissipating, despite pessimistic media reports.

While these concerns have been persistent Caterpillar has been producing some excellent metrics:

  • A forward PE of just 9.8
  • Very impressive return on equity of 36%
  • PEG ratio of 0.8
  • Debt is a touch high at $40 billion, however their impressive ROE illustrates that management effectively manages capital.

Caterpillar has for sometime now been constrained by the "will it, won't it grow" tooing and froing debate over the global economy, but with more of the "it won't" attitude factored into the price. The stock is more likely to surprise on the upside going forward because a good deal of negative sentiment is already priced in.

My third potential target is Deere & Company (NYSE: DE).  After being savaged in the fallout of the GFC, losing nearly 70% of its value, Deere & Company has recovered. Similar to both Caterpillar and Cummins, Deere & Company has essentially tracked sideways for two years. With bullish movements and sentiment shifting into the transport sector, now may be the time Deere & Company makes up for lost time. Deere & Company is supported by some very healthy fundamentals, including:

  • Modest forward PE of 11.2
  • Dividend of 2.1% (supported by a payout ratio of just 23%)
  • Strong earnings growth of 21% quarter over quarter
  • And blockbuster return on equity of 44%

Deere & Company may well be positioned with its sound fundamentals to move upward on bullish sentiment towards the transport sector. With a diverse range of products, Deere is poised to grow and benefit from global growth.

Capturing bullish potential using LEAPS

Below are the latest prices for long-term options for the three companies:

<table> <tbody> <tr> <td> <p><strong>Stock</strong></p> </td> <td> <p><strong>Price</strong></p> </td> <td> <p><strong>Strike</strong></p> </td> <td> <p><strong>Expiry</strong></p> </td> <td> <p><strong>Premium</strong></p> </td> <td> <p><strong>% of Price</strong></p> </td> </tr> <tr> <td> <p>CMI</p> </td> <td> <p>$115.77</p> </td> <td> <p>$120</p> </td> <td> <p>Jan – 2015</p> </td> <td> <p>$17.10</p> </td> <td> <p>14.25%</p> </td> </tr> <tr> <td> <p>CAT</p> </td> <td> <p>$92.25</p> </td> <td> <p>$95</p> </td> <td> <p>Jan – 2015</p> </td> <td> <p>$10.90</p> </td> <td> <p>11.4%</p> </td> </tr> <tr> <td> <p>DE</p> </td> <td> <p>87.82</p> </td> <td> <p>$90</p> </td> <td> <p>Jan – 2015</p> </td> <td> <p>$9.85</p> </td> <td> <p>10.9%</p> </td> </tr> </tbody> </table>

While all three stocks have good fundamentals, my view is that Deere & Company represents the best option. With the lowest option premium, returns will be magnified. Deere & Company was priced over $95 just a month ago. To me, this shows that it would not take much to recoup the cost of the option. The Jan. 15 option offers investors essentially a leveraged effect of 10 to one.

Should the market turn more bullish on the transport sector, and Deere & Company in particular, this could be a very profitable investment. Consider if Deere & Company experienced PE expansion. If its PE moved from 11.2 up to a still conservative 15, we could expect to see a price of about $117. This would provide the Jan. 15 option with intrinsic values (plus any time value) of approximately $27, representing a gain of nearly 200%.

If you are bullish on the transport sector, take the time to consider and evaluate how you can best apply your bullish view in such a way that fits with your risk profile. I have focused here on explaining why I am bullish and how I will apply that view.


JarrodBailey1 has no position in any stocks mentioned. The Motley Fool recommends Cummins. The Motley Fool owns shares of Cummins. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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