MARKETWATCH. Despite oil price rise, transport stocks fly

When crude oil prices gush, transportation stocks stall. So goes conventional Wall Street wisdom. But, lately, 'taint necessarily so. Last week, the price of benchmark West Texas intermediate crude popped up over $19.50 a barrel - up from about $15 a barrel in March. Investors brazenly ignored the oil hike.

Buyers sent the Dow Jones transportation average motoring to record highs. (Meanwhile, the Dow industrial average moved in fits and starts, closing down 49.78 points at 2,272.52. Another rise in the prime interest rate and evidence of a further boost in the inflation rate were negative factors for investors.)

Given that fuel costs are a major drag on airline, trucking, and railroad earnings, what's going on here?

``Oil prices are a big part of the expense formula,'' says Helane Becker, airline analyst at Drexel Burnham Lambert.

``But people forget that expenses are only half the equation. The other half is revenue. That's where the good news is coming from.''

Chief among the positive developments: An improving economy is filling planes. Airline traffic was up 20 percent in April and has climbed 26 percent in the first four months of 1987.

Salomon Brothers analyst Julius Maldutis predicts another 15 percent rise in May traffic, followed by a 10 to 12 percent increase in the third quarter.

At the same time, fare prices are creeping higher. Texas Air, the low-cost carrier which introduced Max-Saver fares in late January, is now tightening discount restrictions and bumping prices up a bit. Other airlines are following suit.

Plus, technically, airline stocks were due for a bounce after being hit by selling about a month ago.

In light of these factors, brokerages have turned quite bullish on airline issues. Salomon Brothers, Oppenheimer & Co., Drexel, and Janney Montgomery Scott are among those issuing strong buy recommendations. Delta Airlines, AMR (American), and NWA (Northwest) top many brokerage lists.

Not so coincidentally, notes Ms. Becker, ``AMR, NWA, and Delta were in town this week and made very upbeat presentations to investors. That's a big change from past management presentations.''

Takeover speculation in Allegis (formerly UAL) has also played a part in pushing up the transportation average. Last week, Allegis clinched a white knight, planes-for-convertible notes deal with Boeing, the aircraft manufacturer.

Initially, the agreement punctured the hopes of some investors that Allegis might be taken over. But Boeing's avowed neutrality has given new life to takeover rumors. The pilot's union is expected to hike its bid any day now.

And arbitrageurs are betting that the sudden trading surge in Allegis stock is indicative of another interested party waiting in the wings.

``Allegis is definitely still in play,'' says Mark Klee of the National Aviation and Technology mutual fund.

Allegis accounts for large portion of the fund's portfolio and Mr. Klee says no profit-taking has occurred yet.

But Mr. Becker at Drexel recently downgraded Allegis from a ``buy'' to a ``neutral'' rating.

``Our feeling,'' he says, ``is that at current prices, it's not trading on fundamentals. It's an `arb' play now.''

On a takeover or break-up valuation basis, airline analysts figure Allegis is worth from $90 to $120 a share. For risk-takers, analyst Louis Markesano at Janney Montgomery Scott in Philadelphia recommends purchasing Allegis at prices under $74 a share.

But he says that on a fundamental ``cash-flow basis, Allegis should be trading at the same level as AMR. So the downside risk is to $57 to $58 per share.''

Another factor boosting the transportation average is a pickup in railroad stocks.

When business is better for heavy industry, agriculture, and the energy sectors in particular, rail traffic climbs. And the weaker dollar is starting to revitalize the industrial sector as evidenced by last week's reported drop in March trade defict figures.

Also, since raw materials, more than finished goods, tend to be carried by the rails (rather than trucks), the ``construction of foreign-owned plants, particularly Japanese, in the United States in order to take advantage of the weak dollar has been increasingly helpful to rails,'' notes Goldman, Sachs & Co. analyst Michael Armellino in a recent report.

Earnings improvements, coupled with the fact that railroad stocks have lagged both trucking and airline stocks, leads Mr. Armellino to expect Burlington Northern, Union Pacific, and Norfolk Southern to provide a 10 to 15 percent total return with ``no more than market risk'' over the next six to 12 months.

If, perchance, investors should embrace conventional Wall Street wisdom about petroleum prices and transportation issues, Armellino argues that railroad cost structures are less senstive to higher oil prices than truckers or airlines.