Railroads that had their valuations slashed in 2015 due to decreased traffic at the very least should see the bleeding slow this year as coal volumes are expected to improve.
Total rail traffic in 2015 declined 6.1 percent to 14.3 million in 2015, according to the Association of American Railroads, an industry group. The industry relies on coal shipments, which compose about 15 percent of rail-cargo volume and as much as a third of its profits — as coal production and shipments go, so do rail profits, says Matt Troy, a New York-based analyst at Nomura Securities International.
Stock for Union Pacific Corp. (ticker: UNP) dropped 34 percent in the past year, while Canadian Pacific Railway Limited (CP) shares declined 37 percent and CSX Corp. (CSX) fell 31 percent.
Coal output in the U.S. fell 10 percent in 2015 to about 900 million short tons, the lowest level since 1986, according to the Energy Information Administration. Consumption also declined 10 percent as warm weather reduced the amount of coal used for heating.
Rail cargo volumes, however, are forecast to stabilize in 2016 on increased coal consumption as winter weather takes hold in much of the nation and natural gas prices increase, the EIA says in a recent report. While it won’t be a blockbuster year for the industry, improved coal consumption may be enough to get the railroads back on track.
“Most people feel (rail profits) won’t be quite as bad in 2016,” says David Tyerman, an analyst at Canaccord Genuity Corp. in Toronto, who covers the rail industry. “We won’t see an increase but the very, very negative growth rates will become less negative. Last year was a really bad year, so maybe this year won’t be quite as bad.”
Warm weather curbs coal consumption. The biggest hit to rail volumes last year was caused by warm weather in much of the country due to the El Nino weather system, which led to the second-warmest year on record for the contiguous U.S. Natural gas prices fell to the lowest in 16 years.
Things are looking up, though, as temperatures in January have been much cooler than those in December. Heating use will rise, boosting natural gas prices, in turn leading to increased coal consumption, the EIA says.
“Higher forecast natural gas prices in 2016 are expected to contribute to higher utilization rates among the remaining coal-fired power plants, which mitigates the effect of lower consumption because of coal-plant retirements,” the agency says in a report. “Coal consumption in the electric power sector is forecast to increase by 1 percent in 2016, as electricity demand rises and electricity generation from natural gas and nuclear decline.”
Grains, autos may be a bright spot for rail. Grain shipments also are forecast to be a bright spot for the industry this year, Nomura’s Troy says.
Soybean production in the U.S. is expected to be a record this year, while corn growers are expected to harvest their third-biggest crop on record, according to the Department of Agriculture. Canadian wheat production is also forecast to be the third-most ever.
Historically high grain and oilseed output means more opportunity for increased rail volume.
Automobile sales also are on the rise, which means more cars will need to be shipped, another potential revenue source for the rail industry. Ford Motor Co. (F) and General Motors (GM) both say their respective annual sales increased by 5 percent in 2015.
Headwinds facing the industry abound. It’s not all good news for the rail industry.
Despite increased coal consumption, inventories of the commodity in October were up by more than a third from the same period a year ago, according to the EIA. That’s carried over through the winter, especially considering last month was the warmest December on record.
Wall Street estimates on coal consumption are too high, and natural gas prices are still relatively low, clocking in at about $2.35, the lowest since 1999, Troy says, which may lead to disappointment for investors.
“The pain will continue near term with Street expectations too high, specifically as it relates to coal,” he says. “The factors that hampered coal traffic in 2015 are still in place. Natural gas in the $2-$3 range will displace coal in the power grid … so there’s no relief in sight.”
And while grain and auto shipments have been a bright spot and are expected to improve further, those industries are a very small part of rail-cargo shipments.
Still, it’s unlikely rail companies will have as bad a year in 2016 as they did last year, analysts say. Rail intermodal — transporting shipping containers and truck trailers on railroad flatbeds — which rose 1.6 percent in 2015, also will be a bright spot for the industry.
The Canadian Pacific-Norfolk Southern deal is being closely watched. Mergers and acquisition activity will be the talk of the industry for at least the next few months as Canadian Pacific continues its takeover pursuit of Norfolk Southern Corp. (NSC).
Norfolk Southern in December rejected a sweetened offer from the Calgary-based company, which is trying to create a cross-border rail company.
While a merger would likely benefit both companies, it’s not looking promising as Norfolk Southern, with a market capitalization of about $23 billion, seemingly has little interest in being acquired by Canadian Pacific, which has a market cap of about $17 billion.
“It would be quite beneficial to both of them from the numbers we’ve run,” Canaccord’s Tyerman says. “If that initiative actually gets done and passes (antitrust oversight), then that could be the biggest development for the industry of the year.”
If a deal is done, it will be in the first half of the year, he says. The key is for Canadian Pacific to make Southern Pacific shareholders a deal they can’t refuse.
“This is going to be a sooner than later thing,” Tyerman says. “It’s not going to drag on for many months. If CP hasn’t found that it has support within a couple months, then I’m not sure it would pursue it further than that.”
Uncertainty is a common theme. Warm weather, should it continue, will further curb demand for coal while historically large stockpiles continue to curb the amount that will need to be shipped. Analysts, however, still see some bright spots.
Rail intermodal — transporting shipping containers and truck trailers on railroad flatbeds — rose 1.6 percent in 2015 and should again improve, analysts say. Stabilization in the coal industry, increased grain shipments and even improving automobile sales in the U.S. will boost railroad companies’ bottom lines, Troy says.
“Railroad stocks are tied to commodities prices, and with the commodities super cycle coming to an end, the railroads are getting caught up in that negative sentiment,” he says. “The railroads were the Internet stocks of the 1800s, but they still have pricing power and they’re still vital to the economy. The rail industry will be back, it’s just a matter of timing. We just need to have coal traffic stabilize.”
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Railroads Expected to Get Back on Track in 2016 originally appeared on usnews.com
