A Disastrous 2015 for Railroads: What's in Store for 2016?
As we prepare to bid adieu to 2015 and step into a new year, a pertinent question bothering investors interested in the railroad space is whether 2016 will be any better for the beleaguered industry than the year that is about to end. From what has passed, railroad stocks have had a harrowing experience in 2015, hit by the persistent weakness in domestic coal shipments.
Since coal is a key revenue-generating commodity for railroad operators, it is only natural that the decline in domestic coal shipments has hurt stocks in the space big time. Soft commodity prices apart, strength of the U.S. dollar has also negatively impacted railroad results. The struggle faced by the railroad operators is evident from the 31.58% year-to-date decline witnessed in the Dow Jones U.S. Railroads Index.
Lackluster Quarterly Results in 2015
The abovementioned headwinds resulted in major railroad operators delivering below-par quarterly results this year. The dullness started from the first quarter itself resulting in the Dow Jones U.S. Railroads Index declining 8.59%. The performance was no better in the second quarter where the Dow Jones U.S. Railroads Index shed 10.73%.
Headwinds related to coal were primarily responsible for the below-par performances of railroad operators in the third quarter of 2015 as well. Moreover, adverse foreign currency movements characterized by the strength of the U.S. dollar, lower fuel surcharges received from customers due to declining fuel costs and slow carload growth from the energy sector wreaked havoc for railroad stocks. The Dow Jones U.S. Railroads Index lost 10.26% in the Jul 1 – Sep 30 period.
Q4 Forecast No Better
To make things worse, there seems no respite for railroads as coal weakness is likely to hurt stocks in the final quarter of 2015 too. This is evident from the disappointing outlooks issued by Kansas City, MO-based Kansas City Southern KSU and Jacksonville, FL-based CSX Corp. CSX at the Credit Suisse industrial conference in Florida earlier this month.
Frank Lonegro, the Chief Financial Officer of CSX Corp. stated that the decline in domestic coal shipments has been steeper than expected in the fourth quarter, results of which will be revealed by the company on Jan 12. The uncertainty prevailing in the energy markets has contributed to the current prevailing sorry state of affairs at the railroad operator.
The glum scenario prompted the company to forecast 2015 earnings per share growth at a mere 3% on a year-over-year basis. This presents a significant slash from the previous projection which had hinted at 2015 earnings growth in mid-single digits.
Lonegro apart, Michael W. Upchurch, Executive Vice President – Finance and Chief Financial Officer of Kansas City Southern, also issued a disappointing outlook expecting revenues in the fourth quarter to decline in high-single digits on a year-over-year basis.
Railroad Stocks Continue to Tumble
The bigwigs in the U.S. railroad space have seen their stocks considerably shedding value this year, once again due to coal-related headwinds. While shares of CSX Corporation have declined 28.4% on a year-to-date basis, Omaha, NE-based Union Pacific Corp. UNP is down almost 35% so far this year.
Furthermore, shares of Norfolk Southern Corp. NSC which is headquartered in Norfolk, VA and Kansas City Southern have declined 21.91% and 39.74% respectively on a year-to-date basis. The 17.21% year-to-date decline witnessed in the Dow Jones transportation average index is primarily due to the below-par showing of the railroad operators.
Bearish Zacks Industry Rank
The Zacks Industry Rank #240 for the “Trans-Rail” segment places it at the bottom 1/3rd of the 260+ member industry group and indicates the group’s near-term Negative outlook. The absence of stocks in the above segment with a rating better than a Zacks Rank #3 (Hold) is a further indication of the sorry state of affairs for railroads. With buy-ranked stocks having a zero presence, investors interested in the railroad space should exercise caution and preferably wait for a better entry point.
“Dirty Coal” to Hurt Railroads in 2016?
There is no doubt that coal has turned into a splitting headache for railroad operators. While exports continue to be affected by the strong dollar, softness in the energy sector has encouraged utilities to switch to burning natural gas (which is much cheaper).
With energy markets expected to remain challenged in 2016 as well, most railroads like CSX Corp. are expecting intermodal growth to bail them out. The company continues to step up highway-to-rail conversions to gain a significant share of the expected 9 million volumes in the East that are well-positioned for intermodal business.
According to the Association of American Railroads (AAR), in the first 50 weeks of 2015, U.S. railroads reported cumulative volume of 13,851,558 carloads, down 5.6% from the same period last year. However, intermodal units over the same time frame increased 1.6% year over year, reflecting the strength in the business.
With railroads in the doldrums and no recovery in sight in the upcoming year, the possibility of mergers and acquisitions (M&A) in the space cannot be ruled out. Calgary, Canada-based railroad operator Canadian Pacific Railway Limited CP is looking to acquire Norfolk Southern but all its attempts so far have been rejected by the latter.
While further updates on the issue are awaited, some other railroad operators like Kansas City Southern are attractive buyout candidates as well due to their cheap valuations. However, mergers in the railroad space are not easy as they are subject to severe regulatory restrictions. These restrictions are a major reason why there has been no merger or acquisition in the U.S. railroad industry for over a decade now.
To Wrap Up
As an approach to overcome the difficult times and remain viable, railroads are resorting to measures like lowering of headcount and trimming of capital spending. Nevertheless, it is still poised to be a difficult phase for stocks in the space as demand for coal is not likely to improve radically any time soon.
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KANSAS CITY SOU (KSU): Free Stock Analysis Report
CSX CORP (CSX): Free Stock Analysis Report
UNION PAC CORP (UNP): Free Stock Analysis Report
NORFOLK SOUTHRN (NSC): Free Stock Analysis Report
CDN PAC RLWY (CP): Free Stock Analysis Report
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