5 Jul

Lower Volumes Could Hurt US Railroads’ Revenue Growth in Q2

WRITTEN BY Anirudha Bhagat

US rail traffic fell in Q2

According to data compiled by the AAR (Association of American Railroads), US rail traffic fell for the 23rd straight week. US railroads’ freight volume declined 5.5% YoY to 533,164 railcars in Week 26, which ended on June 29.

Lower Volumes Could Hurt US Railroads’ Revenue Growth in Q2

For the second quarter, US railroads recorded a 4.3% decline in overall rail traffic volume, which was much higher than the 1.8% fall they had registered in the first quarter (calculated based on AAR weekly rail traffic data). These companies hauled ~6.8 million railcars during the quarter compared with ~7.1 million railcars in the year-ago quarter.

The ongoing trade disputes with China and European countries negatively impacted rail traffic volume in the second quarter. Also, cheap natural gas prices and floods across several North American regions could have contributed to a significant plunge in second-quarter US rail volume.

Among major railroad companies, Union Pacific (UNP) reported a 4% YoY decline in its rail traffic volume for the second quarter. The company’s carload traffic fell 2%, while intermodal volumes plunged 6% in the quarter. CSX (CSX) also recorded a 4% YoY decline in its overall rail traffic in the second quarter. The YoY decline of 10.3% in intermodal units partially offset the 1% rise in the carload traffic volume.

Norfolk Southern’s (NSC) rail traffic fell 3.8% YoY in the quarter. The company’s carload and intermodal volumes fell 3.5% and 4%, respectively, in the second quarter.

Sluggish revenue growth expectations

Lower freight traffic volumes negatively impacted US railroad companies’ top-line results in the first quarter, and Wall Street analysts’ revenues forecasts suggest that the trend will continue in the second quarter as well.

Lower Volumes Could Hurt US Railroads’ Revenue Growth in Q2

Analysts project Union Pacific’s second-quarter revenues to grow just 0.5% YoY to $5.7 billion. In the first quarter, the company’s revenues had fallen 2% YoY to $5.4 billion. The company’s first-quarter results and analysts’ projection for the second quarter is in contrast with its performances in the preceding four quarters. Previously, Union Pacific had registered high-single-digit revenue growth.

Wall Street analysts forecast that revenue growth for CSX will further slow in the second quarter. For the quarter, they expect top-line growth of 1.7%, which is much lower than the 4.8% growth it had registered in the first quarter. The company had registered double-digit top-line growth in the last two quarters of fiscal 2018.

Similar is the case with Norfolk Southern. For the second quarter, analysts anticipate revenues to increase 2.9% YoY, signifying a further sluggishness compared with the first quarter when it recorded a 4.5% YoY increase. Moreover, the revenue growth projection for the quarter is significantly lower than the high-single-digit increase it had registered in the last three quarters of fiscal 2018.

Analysts’ earnings projections

Analysts’ earnings estimate for the second quarter reflects a significant negative impact from sluggish top-line growth. However, increased pricing and railroad companies’ sustained focus on cost-cutting and improving efficiency initiatives are likely to offset the negative impact partially. Nonetheless, on a YoY comparison basis, their growth rate is expected to slow down significantly.

Lower Volumes Could Hurt US Railroads’ Revenue Growth in Q2

Analysts’ second-quarter earnings estimate for Union Pacific, CSX, and Norfolk Southern is $2.18, $1.11, and $2.81, which reflects YoY growth of 9.9%, 10%, and 12.4%, respectively. The YoY earnings increase projections are significantly lower than the respective companies’ growth rates in the past five quarters.

Union Pacific’s earnings have grown in the high-double-digit range in the previous five quarters. CSX and Norfolk Southern have registered over 30% YoY bottom-line growth in the preceding five quarters.

Railroad stocks’ performance

Railroad stocks have made a remarkable run this year so far. Despite sluggish top-line growth expectations, investors seemed confident about US railroads’ capability of delivering impressive bottom-line results. Railroads’ initiatives to improve the operating ratio, cut costs, and shareholders’ friendly moves have also driven the stocks higher.

Lower Volumes Could Hurt US Railroads’ Revenue Growth in Q2

The majority of the railroad stocks have outperformed the returns of the broader market as well as the iShares Transportation Average ETF (IYT), which invests in Dow Jones listed US transportation stocks. Stocks of Union Pacific, CSX, Norfolk Southern, and Kansas City Southern (KSU) have gained 24.3%, 26.6%, 35.4%, and 30.4%, respectively, YTD. The Dow Jones and IYT ETF have risen 15.6% and 14.8%, respectively, YTD.

Analysts’ recommendations

Though analysts have given a bullish recommendation to most railroad stocks, their target suggests minimal upside potential in these stocks over the next year. Union Pacific, CSX, Norfolk Southern, and Kansas City Southern have a “buy” recommendation, but their respective target prices signify a return of a mere 6.6%, 3.7%, 4.6%, and 6.2%, respectively.

Lower Volumes Could Hurt US Railroads’ Revenue Growth in Q2

Wall Street’s lower target prices could be due to an already massive upswing in railroad stocks in the year so far. As mentioned above, all these four stocks have gained over 20% YTD, making them relatively overvalued compared to the transportation industry’s average. The industry’s one-year forward PE ratio is 13.8x, while Union Pacific, CSX, Norfolk Southern, and Kansas City Southern have PE ratios of 19x, 18x, 18.5x, and 18.4x, respectively.

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