In spite of slow economic growth last year, Canadian transportation stocks outperformed the TSX benchmark last year with a return of 21 per cent.
Further gains are expected in 2013 even though real GDP growth is forecast at two per cent in the U.S. and 1.7 per cent in Canada, according to CIBC World Markets.
"Despite the share price move among the transportation equities in 2012, we still see more upside this year, reflecting the industry's earnings resiliency and cash flow generation," Jacob Bout wrote in a report.
CIBC analysts have upgraded price targets for a string of companies, including Canadian National Railway (TSX:CNR), Canadian Pacific Railway (TSX:CP), WestJet Airlines (TSX:WJA) and trucking firm TransForce (TSX:TFI).
It expects Montreal-based CN to focus on capturing "a disproportionate share of freight volume growth" instead of realizing any material improvements to its industry-leading operating efficiency.
Two intermodal customers have already switched to CN while rival CP simplifies its intermodal train design and trims the number of destinations. CN is also well-positioned to double its carloads in crude and export coal and to reap the benefits of a U.S. housing recovery, said Bout, who also noted there was a risk that chief operating officer Keith Creel could jump to CP to become heir to CEO Hunter Harrison.
After a honeymoon year that saw it install a new board and CEO, they Calgary-based CP Rail is "heading towards a year of execution in 2013," the report added.
CP has already announced the closure of terminals and hump yards, returned thousands of railway cars and locomotives and cut 1,700 positions. But the railway still has more work to do despite the risks of labour disruption and curtailed revenue growth.
Cameron Doerksen of National Bank Financial said the market will remain patient for a while but the railway needs to show "tangible improvement" in its operating ratio in 2013. He said CP's current share price already prices in that its operating ratio will fall to the mid-60s in 2016.
"Expectations for CP are very high and failure to meet earnings estimates could lead to a pullback in the stock," he wrote in a report.
Meanwhile, industry observers expect the airline industry will improve as it continues to constrain capacity growth and increase prices.
The International Air Transportation Association recently raised its forecast for global airline profits to US$8.4 billion this year. That would represent a 25 per cent increase from what it expects to have been earned in 2012. Profits are expected to rise even though fuel prices are predicted to be at similar levels as in 2008 when the industry lost US$26 billion.
CIBC said Air Canada (TSX:AC.B) and WestJet's pre-tax operating income (EBITDA) should grow by 20.4 and 7.5 per cent respectively.
It said both carriers can achieve growth because Air Canada is looking to expand it share of the international leisure travel market through the introduction of low-cost carrier Rouge, while WestJet seeks to grow its share of domestic traffic through the launch of regional carrier Encore.
Doerksen said WestJet's new fare structure that will add premium economy seating will add $50 million to $80 million in annual revenues (up to $50 million for the nine months of 2013) and generate 25 to 40 cents per share in earnings.
The introduction of premium economy, enhanced schedules to key business markets such as New York and the addition of Encore should allow WestJet to grow its 10 per cent share of the lucrative corporate travel.
Bout sees a number of possible catalysts for Air Canada's stock this year, including an extension of the pension moratorium and launch of premium economy fares.
Transat's (TSX:TRZ.B) profitability should continue to grow but added capacity from Sunwing, WestJet and Air Canada will continue to challenge the tour company during the key winter season.
Meanwhile, trucking capacity is expected to get tighter, in part due to a driver shortage that is forecast to widen in the second half of the year.
"We believe this will support freight rates despite the weak economy and any pickup in volumes will result in significant upward pressure on pricing," Bout said.
But Walter Spracklin of RBC Capital Markets said weak economic activity in the fourth quarter resulted in soft prices and volumes for freight carriers. His estimates for 2013 and 2014 remain unchanged but he has tempered his fourth-quarter revenue forecasts for several trucking firms.
Several analysts say industry leader TransForce should continue to expand its profits due to synergies and efficiencies from the integration of Loomis Express and other acquisitions.
On the Toronto Stock Exchange, CN's shares closed up 73 cents at $94.52 in Friday trading. CP gained 40 cents to $109.17. WestJet and Air Canada touched 52-week highs but closed at $22.02 and $2.40 respectively. Transat gained three cents to $5.99 while TransForce was off four cents to $22.01.