One can overlook regional centres and stocks that benefit from their growth when there is so much focus on East Coast capital cities. Small transportation companies that lug commodities – or people – in regional or remote areas rarely get much attention.

Personal experience

I considered the transport sector after returning from a week’s holiday in North Queensland. The airports seemed busier than usual and more trucks were on the roads than I’d seen in a while. Locals told me their economy was slowly improving, as mining picked up.

Basing investment decisions only on anecdotes, particularly those from casual observations, is, of course, foolish. But it is remarkable how investors underestimate their best tools – their eyes, ears and personal experiences – when embarking on stock selection.

The high number of trucks encouraged me to look at small transport stocks, a part of the market I have neglected, the exception being aviation-related stocks where I have had a favourable view on Qantas Airways, Air New Zealand, Auckland Airport and Sydney Airport for some time.

I had not examined Alliance Aviation Services, Regional Express Holdings, Chalmers, CTI Logistics, K&S Corporation, Lindsay Australia, MMA Offshore or other small transport stocks. A few of those stocks are trading at near five-year highs, or starting to recover.

It’s well known that transport stocks are a leading indicator for the economy and the stock market. That’s why the Dow Jones Transportation Average index in the United States gets so much attention. Higher transportation demand suggests a strengthening economy.

Do not presume a handful of micro-cap transport stocks on the ASX is a reliable harbinger of our economy. But a pick-up in the mining sector has obvious benefits for many regional cities and their transport companies. That was obvious on my latest trip in Queensland.

My concern is the drought and its effect on transportation demand in agriculture. Parts of North Queensland were as dry as I had seen them. Pray for rain but until then, avoid transportation companies that rely heavily on soft commodities in drought-affected areas.

Instead, focus on transport stocks leveraged to hard commodities. As mining activity continues to improve, more goods and workers will need to be moved. I’m not suggesting anything like the mining boom again, but the market is paying more attention to the trend.

Chalmers, owner of container parks and freight services, has a one-year total return (including dividends) of 27%. Resource-focused airline operator Alliance Aviation is up 67% in a year and Regional Express Holdings (REX) is up 23% during that time.

MMA Offshore is up 36% over one year, off a low base. The vessel operator’s five-year annualised return is awful (minus 40%), but some savvy fund managers have started to build positions in MMA (formerly Mermaid Marine Australia) this year and see it as a turnaround play.

Several small transport stocks have negative one-year returns and most have disappointed investors over the past five years. Industry conditions remain tough, competition is high, and the drought adds a huge layer of uncertainty.

Only experienced investors who understand the risks of less liquid micro-cap stocks, and the challenges of highly cyclical sectors, should consider small transport stocks.

Also, some have diverse operations and are not a pure play on improving resource-sector or regional fortunes. For those who can tolerate the risk, here are three small transport stocks worth watching.

1. Alliance Aviation Services (AQZ)

Regional airports were filled with people in fluorescent vests during the mining boom. This army of “fly-in, fly-out” (FIFO) workers was good news for regional airlines, such as Alliance Aviation, that focused on flying miners to and from remote areas.

Queensland-based Alliance raised $74 million through a float and listed on the ASX in December 2011, near the mining-boom peak. Alliance’s $1.60 issued shares soared above $2.30 within a year of listing, then plunged below 50 cents during the downturn.

Alliance has recovered to $2.45, amid improving earnings growth, a strengthening balance sheet, fleet investment and better diversification of its operations.

The company’s before-tax profit for FY18 grew 33% to $26.1 million, net debt fell by almost a quarter and a record dividend was paid. Four aircraft were added to Alliance’s fleet and total flight hours had good growth.

Alliance has a positive view on FY19, expecting contract flying hours to increase because of higher demand from the resource sector for FIFO transportation and from tourism contracts.

The market needs to catch its breath on Alliance after price gains in the past two months. But there’s a lot to like about its longer-term prospects as mining activity increases.

Chart 1: Alliance Aviation Services (AQZ)

Source: ASX

2. Chalmers (CHR)

The road-transport, logistics-services, and warehousing and container-storage group is trading near its 52-week high of $4.15 (now $4). That’s despite a disappointing FY18 and small loss.

The container-park operations underperformed, partly because of a storm in November 2016 that toppled 900 containers and affected Chalmers’ customer retention. The business lost two of its largest clients and a third of them reduced their exposure to Chalmers, to spread risk.

Moreover, Chalmers has been exposed to agribusiness in recent years, a challenging position, given climatic conditions. Chalmers has had some success in diversifying the business to other sectors, but as I said earlier, agribusiness-related transport stocks are worrisome.

So why the market interest in Chalmers, given its recent performance and challenging outlook? A few paragraphs in the Annual Report (page 4) note the review of the company’s property holdings in inner-west Melbourne, an area undergoing much development.

Chalmers is considering combining its adjoining properties to create a new development precinct. The West Gate Tunnel project, which will remove trucks from parts of the inner-west, could hasten the area’s gentrification. Other former industrial sites are being redeveloped into residential precincts and perhaps Chalmers can do the same.

Chalmers in September announced that its Melbourne Land Holdings had been identified as part of a key strategic site for renewal and planning by the Victoria Planning Authority.

Chalmers’ land and buildings are valued at $22.3 million on the balance sheet. It’s a good bet that a large parcel of industrial land in inner-west Melbourne, which is suitable for residential development, is worth more than the current balance-sheet valuation.

The annual report notes: “Due to the growth in value of the land holdings in Yarraville and Brooklyn (in Melbourne) being driven by significant urban encroachment in the area… the company has been extensively engaged with its neighbours and government to bring forward the opportunity this gives for Chalmers.”

The company’s property holdings could unlock more value in Chalmers. They will need to: it’s hard to buy the stock on its transportation operations alone, right now.

Chart 2: Chalmers (CHR)

Source: ASX

3. MMA Offshore (MRM)

I keep an eye on stocks that savvy small-cap fund managers buy, particularly when they emerge as substantial shareholders. Lots of fund managers are happy to talk about stocks they own when their positions are set, less so when they are building a stake.

One of the market’s best small-cap judges, Paradice Investment Management, increased its holding in MMA from 5.8% to 7.2% in March this year. Another manager, Eley Griffiths Group, emerged as a substantial shareholder (5.6% stake) in June and Spheria Asset Management and Thorney Opportunities are also on the share register.

They, and other fund managers, must see the embattled MMA, a provider of marine services to the oil and gas industry, as a turnaround play. The company’s earnings were crushed during the resource downturn, there were heated ownership battles and concerns about its debt and leadership at the time.

Valued at more than $900 million in early 2013, MMA is now capitalised at $206 million. MMA noted that conditions over the past few years were as challenging as it had seen them.

The latest Annual Report is cautiously more optimistic. MMA said the broader energy market improved over FY18, as the oil price recovered. Major oil companies reporting higher profits bodes well for higher vessel demand in the next few years.

MMA notes that the global vessel market remains oversupplied, but says many vessels that have been laid up (due to lower demand) are unlikely to return to action because of cost and safety issues. Rising demand and less vessel supply overhang is good news for MMA, but it will take time to filter through to earnings and improved market sentiment.

Often, the market gives up on stocks that burn investors, and misses early signs of recovery. That could be the case with MMA. The stock is not for the risk averse.

Chart 3: MMA Offshore (MRM)

 Source: ASX

• Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor All prices and analysis at October 9, 2018.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regard to your circumstances.