Reports Show Challenges Facing Railroads

Investment banking firm Cowen and Company recently released three reports that reflect tough times for railroads yet contend that things are not catastrophic either.

The New York-based firm noted that in the fourth quarter of 2019 freight volumes fell by 7.5 percent when compared to the same period of 2018.

In comparing the last quarter of 2019 to the earlier quarters of the year, carloads fell by 1.4 percent, 4.8 percent and 4.4 percent by respective quarter for a full-year decline of 4.0 percent compared with 2018.

Cowen said railroads last year handled volumes that were similar to those expected during an economic recession.

It said, though, that the advent of precision scheduled railroading has enabled Class 1 railroads to reduce their expenses, which helped to stimulate earnings growth despite volume declines.

Among the long-term forces affecting railroads are intermodal growth, decline in export coal, and the state of the overall economy.

Cowen said these resulted in Class I railroads falling short of expectations.

It likewise has lowered its expectations for 2020 on earnings per share forecasts for most Class 1 railroads.

The exception is Kansas City Southern because Cowen analysts believe that carrier will benefit from the shifting of supply chains to South and Central Mexico.

In another study released by Cowen, a survey of rail shippers found they are expecting price increases of 3.0 percent below the survey’s long-term average.

Cowen described this as a positive for railroads but noted carriers continue to confront a challenging near-term demand environment and the worst volume declines since 2009.

The report said data show that railroads haven’t sought to increase their volume by lowering their freight rates.

The average positive rating given by shippers to rail service rose to 60 percent from 53 percent the third quarter of 2019 with satisfaction rising with all railroads other than Norfolk Southern.

In a third report, Cowen said railcar demand appears to be holding at or just below the levels of the past quarter despite rail traffic declines and the continued implementation of PSR.

Cowen said about 51 percent of all shippers surveyed said they will or may order railcars in the next 12 months.

That compares with 53 percent who said that during the third quarter survey.

About 49 percent of shippers said they do not plan to order railcars compared to 48 percent in the previous quarter survey.

Wall Street Expects RR 4th Quarter Earnings to be Down

The financial report cards for the fourth quarter of 2019 will be released soon, but Wall Street analysts are already predicting that earnings will be down at four of the six publicly traded Class I railroads.

Wall Street doesn’t expect such steps as reducing expenses, raising freight rates and buying back stock will be enough to overcome declines in traffic volumes.

Analysts are estimating that earnings per share will be down by 1 percent.

CSX will be the first railroad to report its fourth quarter results when it announces them on Jan. 16.

Analysts expect CSX earnings to be down by 1.9 percent because its traffic has fallen by 6.5 percent during the quarter according to figures it has provided to the Association of American Railroads.

Norfolk Southern will give its fourth quarter report on Jan. 29. Its earnings are expected to decline by 8.5 percent in the face of a 9.1 percent fourth quarter falloff in traffic.

Canadian National will report earnings on Jan. 28 and they are expected to fall by 16 percent on the heels of a 7.8 percent drop in traffic in the fourth quarter.

The January earnings calls are expected to be a platform for management at Class 1 railroads to offer their financial outlooks for 2020 as well as discuss their capital spending plans.

CN Adjusts 2019 Outlook in Aftermath of Strike

Canadian National has revised its 2019 full-year financial outlook to reflect the effects of an eight-day strike that recently ended.

CN estimates that the strike by members of the Teamsters Canada Rail Conference will affect the company by 15 cents of earnings per share.

The revised full-year financial outlook now calls for adjusted diluted EPS growth in the low-to-mid single-digit range versus last year’s adjusted EPS of CA$5.50.

In October CN had projected an adjusted diluted EPS growth in the high single-digit range for the year.

The strike began when more than 3,000 conductors and rail yard workers walked off the job during contentious negotiations for a new contract.

The union workers are in the process of voting on ratification of the tentative agreement that ended the strike.

Moody’s Downgrades Outlook for Railroads to Negative

The railroad industry has taken another blow, this time from Moody’s Investors Service which has changed its outlook for North American railroads as “negative.”

Moody’s had last April described the industry as “stable” but even that had been a downgrade from an outlook of “positive” rendered earlier.

In its latest report on railroads, Moody’s said the industry is being hindered by lower freight volume, weaker pricing gains causing revenue drops, and declining coal traffic.

Moody’s expects intermodal traffic to drop along with overall rail freight volume declining by 1.75 percent to 3 percent over the next year to 18 months. Overall railroad revenue is expected to remain flat.

The decline in railroad coal traffic is projected to accelerate unless there are changes in federal policy, technological innovations, or increased natural gas prices.

The demand for coal is seen as falling by 7 percent per year over the next decade.

But there is more than declining coal traffic that is hurting railroads.

The trucking industry has expanded capacity and that is putting pressure on the ability of railroads to price their product to lure or keep freight, particularly intermodal shipments, on the rails.

“Heightened competition from truck carriers for intermodal and certain other freight continues to weigh on the North American railroad sector,“ said Moody’s Rene Lipsch, a vice president and senior credit officer. “The excess of trucking capacity has been a primary driver of softening pricing gains in the industry.”

Class 1s to Report Stellar 2nd Quarter Results

Wall Street analysts are expecting North America’s Class 1 railroads to report sterling financial results for the second quarter of this year because traffic has continued to rise and the railroads have also imposed rate increases.

A review of analysts’ projections that was undertaken by Trains magazine found that the Wall Street mavens are expecting earnings per share to rise by an average of 23 percent for all roads except Canadian National.

The rate increases have been made possible in part because of limited capacity in the trucking industry.

However, some analysts believe that railroad service issues have prevented them from reaping traffic growth opportunities, particularly in intermodal traffic.

The railroads have seen their intermodal traffic grow by around 5 to 6 percent and reach record-setting levels, but it could have been higher.

The demand by online retailers, such as Amazon, for brown paper and cardboard boxes has pulp and paper mills operating at high capacity yet they are relying on trucks and not rail to ship that commodity.

Pulp and paper traffic by rail is flat compared to last year and well below the five-year average.

Analysts are likely to be asking questions in coming weeks about how a trade war that is underway with the imposition of tariffs in a tit for tat fashion will affect the financial performance of railroads down the line.

The Association of American Railroads has noted that 42 percent of rail traffic and 35 percent of railroad revenue is linked to trade.

With the trucking industry operating at 100 percent, there remain opportunities for railroads to gain market share in freight volume.

CSX will report its second quarter results on July 17 while Norfolk Southern will issue its report on July 25.

NS Sets 4 Quarterly Financial Records

Norfolk Southern said on Wednesday that it set four quarterly financial records in the first quarter of 2018.

The records included a new first quarter high or low for earnings per share at $1.93, up 30 percent year over year; net income at $552 million, up 27 percent; income from operations at $835 million, up 10 percent; and the operating ratio at 69.3, down 1.3 points.

In a news release, NS said that a lower effective income tax rate helped boost net income.

Railway operating revenue rose 6 percent to $2.7 billion and volume increased 3 percent to 1.9 million units compared with first-quarter 2017 results. The operating ratio was 69.3 percent, also a first-quarter record.

Intermodal revenue jumped 19 percent to a record $678 million and volume rose 8 percent to 1 million units.

NS said its intermodal business benefited from tightening truck capacity, rising truck prices, ongoing e-commerce growth and increasing rail/intermodal rates.

Coal revenue increased 3 percent to $343 million, although volume declined 4 percent to 249,100 units, and merchandise revenue inched up 1 percent to $1.6 billion while volume in the sector decreased 2 percent to 606,100 units.

Railway operating expenses increased by 4 percent to $64 million year over year due to $1.9 billion as higher fuel prices and increased costs associated with lower network velocity were offset by efficiency gains.

Fuel costs jumped 25 percent to $266 million as the price for a gallon of diesel climbed 21 percent in the quarter.

“We are pleased with the continued improvement in our financial performance and the growth in our business,” said NS Chairman, President and CEO James Squires in a statement. “We are focused on improving service for our customers to position us for future growth and efficiency that will benefit both our customers and shareholders.”

Squires said the outlook for the remainder of 2018 is promising.

“We are increasing our expected annual share repurchases to $1.5 billion, confident that we will deliver strong financial performance,” Squires said.

NS Net Income Rose in 4th Quarter 2017

Norfolk Southern on Wednesday reported fourth quarter 2017 adjusted net income of $486 million, or $1.69 per diluted earnings per share compared with $416 million, or $1.42 per diluted share, in the fourth quarter of 2016.

For calendar year 2017, NS said it earned $1.9 billion in adjusted net income versus $1.7 billion in 2016. Adjusted diluted earnings per share were $6.61, an 18 percent increase over last year’s record diluted EPS of $5.62

Including the impact of the Tax Cuts and Jobs Act of 2017, NS had net income of $3.97 billion in the fourth quarter with diluted EPS of $13.79.

For all of 2017, net income including the impact of tax reform was $5.4 billion and diluted EPS were $18.61.

Other key fourth quarter metrics showed operating revenue rising 7 percent to $2.7 billion compared with 2016, NS said overall volumes increased 5 percent reflecting growth in intermodal, coal and merchandise traffic.

Operating expenses during the quarter fell 4 percent to $1.7 billion compared with the fourth quarter of 2016.

The effect of the tax change legislation cut operating expenses by $151 million, which more than offset increases that resulted from volume growth and higher fuel prices and incentive compensation.

Adjusted income from railroad operations rose 13 percent on a year-over-year basis to $863 million.

The fourth quarter operating ratio was 67.7 percent, a 170 basis point improvement over the operating ratio in the same period in 2016.

For the year, NS saw railroad operating revenue rise 7 percent to $10.6 billion compared with 2016.

NS attributed the increase to 5 percent growth in the major commodity categories of coal and intermodal traffic.

Railroad operating expenses increased 2 percent to $7 billion compared with those in 2016 with the increase attributed to higher diesel fuel prices, increased incentive compensation, higher inflationary costs and volume growth. Those higher costs were offset in part by efficiency savings and the benefit of tax reform.

For 2017, the operating ratio of 67.4 percent was a 150 basis point improvement over 2016’s operating ratio.

“Norfolk Southern is open for growth, and we are optimistic as we head into 2018 that the current economic environment will provide an opportunity for continuing growth,” said NS CEO James Squires.

During 2017, NS will spend more than $1.7 billion to maintain its infrastructure and support economic growth. In 2018, NS plans capital expenditures of $1.8 billion.

CSX Expects Dip in 4th Quarter Earnings

CSX is projecting that its fourth quarter earnings will be below those that it posted in the same period of 2014.

At the Baird International Conference in Chicago this week, CSX Chief Financial Officer Frank Lonegro said the company expected mid-single digit, full-year earnings per share growth.

Longegro said intermodal growth and efficiency initiatives are offsetting a $450 million decline in coal revenue.

“CSX has leveraged its diverse portfolio and network reach to consistently deliver record earnings per share growth, despite declines in coal revenue of more than $1 billion over the past four years,” Longegro said in a statement. “While we expect the energy market headwinds to continue in 2016, we are focused on capturing opportunities in intermodal and industrial markets, and on delivering excellent service for customers to support our pricing, growth and efficiency targets.”

The railroad expects to continue to see growth in 2016 in intermodal traffic due to highway-to-rail conversions.

CSX also expects that efficient service for automotive customers will lead to industrial market growth as North American production of light vehicles increases.

NS, CSX Optimistic About Traffic Growth

Railroad executives sounded an optimistic note when discussing the future this week during the 8^th Annual Global Transportation Conference.

They acknowledged that coal traffic this year was down 9.3 percent through the end of August but cited service improvements, rising prices, and lower costs as offsetting the falloff in coal business.

Overall, rail traffic is down 1 percent during 2015 although intermodal has shown growth.

Fredrik Eliasson, the executive vice president and chief sales and marketing officer of CSX, said his railroad still expects mid single-digit earnings growth in 2015.

CSX expects domestic coal revenue to fall by more than $400 million.

“In the third quarter, we see strong pricing that reflects the value of our service, and we continue to drive greater asset utilization and reduce costs as we match our resources with demand while improving our service product,”

Eliasson said. “At the same time, overall volume to date is down about 2 percent, with both our domestic coal and merchandise markets tracking slightly below the company’s original third quarter expectations.”

A Norfolk Southern executive said his railroad would be surprised if overall traffic fell in 2016, but NS is feeling the pinch of declining coal traffic.

“We feel like we’re at a floor of 20 million tons [per quarter] for utility coal,” said Alan Shaw, the NS executive vice president and chief marketing officer.

Shaw said that flat coal traffic when coupled with the strong growth potential for NS’s intermodal and auto networks means a lot of upside in 2016.

NS continues to face challenges in its domestic intermodal network with increased trucking capacity limiting growth opportunities.

Service issues have hindered the railroad’s ability to capture traffic that’s currently moving via highways.

NS has addressed those issues by hiring 600 train and engine employees this year and has plans to hire another 400 by the end of the third quarter.

Shaw said that NS has redeployed crews from coal fields to areas of the railroad where traffic is growing and it is short of crews.

NS believes it is well-positioned to take advantage of changes in the U.S. economy, including energy and manufacturing shifts and a rebound in housing.

Shaw said NS is targeting revenue growth through pricing and volume gains. He said that improving service by increasing capacity and reducing bottlenecks is a key part of that strategy.