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BofA upgrades three largest railroad operators ahead of potential work stoppage

·4 min read

Analysts at Bank of America upgraded shares of the three largest publicly-traded railroad operators on Monday, despite the threat of a labor strike that could paralyze the industry later this week.

Ken Hoexter and his team at Bank of America Global Research upgraded shares of Canadian National (CNI), Canadian Pacific (CP), and Union Pacific (UNP) to Buy from Neutral in a note to clients on Monday, citing improving volume and labor trends.

"We recognize we are raising ratings days before Friday's deadline for the rails to agree [to new labor deals]," Hoexter wrote. "We would view any stoppage as a buying opportunity, as we would expect Congress to mandate back to work terms."

Shares of all three companies rose on Monday amid a broader rally for the U.S. equity market.

Hoexter notes rail carload volumes have trended higher of late, rising for 10 straight weeks after having declined for 37 of the prior 43 weeks. Carload volumes are still down 1.4% over last year and off 4% when compared to 2019, but so far in Q3 volume is up 1.4% against last year.

Increased hiring at the railroads has, in part, boosted recent performance, with Hoexter writing: "Rail volumes year-to-date have been constrained by a lack of capacity as shortages in Train, Engine, & Yard (TE&Y) staff limited the carriers' service."

A surge in hiring during the last several months has seen headcount at the Class 1 rails — which include the three companies BofA upgraded, as well as BNSF, Amtrak, CSX, Norfolk Southern, and Kansas City Southern (which is being acquired by Canadian Pacific) — rise to nearly 81,000 during the quarter, up 2.9% from last year.

Class 1 Rail Total Workforce (2021-2022-to-date)
80,978 in total Class 1 Rail headcount
Hiring at railroads has accelerated this year as operators look to clear a backlog caused in part by being short-staffed. (Source: Bank of America Global Research)

More than 90,000 rail workers from 13 unions around the country have threatened to strike Friday if the unions that represent them can't reach an agreement with the National Railway Labor Conference, which represents the rail companies. Leaders of 11 of the 13 unions have reached a tentative deal but two of the biggest unions representing rail workers are still holding out.

A strike could impact one-third of cargo in the United States and would cost the American economy $2 billion a day, according to Association of American Railroads.

"Failure to act could idle more than 7,000 trains daily and trigger retail product shortages, widespread manufacturing shutdowns, job losses and disruptions to hundreds of thousands of passenger rail customers," AAR President and CEO Ian Jefferies wrote in a statement.

The White House said over the weekend it is "closely monitoring the negotiations."

Some railroads have made plans to reduce services in preparation for a potential strike.

UNITED STATES - AUGUST 30: A Union Pacific freight train passes the railroad crossing in Nipton, California on Aug. 30, 2019. (Photo By Bill Clark/CQ-Roll Call, Inc via Getty Images)
A Union Pacific freight train passes the railroad crossing in Nipton, California on Aug. 30, 2019. (Photo By Bill Clark/CQ-Roll Call, Inc via Getty Images)

Union Pacific Railroad announced late last week the company, "will begin to secure hazardous and other security-sensitive materials on our property for the safety of our customers, employees and communities we serve. In addition, we will embargo new shipments of hazardous commodities until those shipments can safely arrive at their destination. This is a proactive measure we are taking ahead of any potential work stoppages due to an impasse in labor negotiations."

If there is no contract this week, Congress could intervene by imposing a settlement on both sides or order a new cooling-off period.

Ultimately, more hiring and the likely resolution of labor disputes will improve service for the railroads, which is the most important factor, long-term, for these companies' stocks.

"Service performance has been a driver of rail stocks, more so than rising rates given the rails ability to sustain price above inflation," Hoexter wrote.

"While the pull back of fuel and higher labor costs will impact near term results, improvement in service should allow rails to continue relative outperformance. Rails outperformed the S&P 500 in 20 of the past 22 years."

Shares of all three railroads have outperformed the S&P 500 so far this year.

Dani Romero is a reporter for Yahoo Finance. Follow her on Twitter @daniromerotv

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