Analysts Fearful About Railroads

The Dow transports pretty much moved in lockstep with the broader markets during last month's rally. For followers of the Dow Theory, this was a positive sign.

The problem, however, is that there were nasty undercurrents at the same. Specifically, about 40% of the earnings estimates for Transportation-Railroad were cut in March. Among the companies targeted by the negative revisions are Burlington Northern (BNI - Analyst Report), CSX Corporation (CSX - Analyst Report), Canadian National (CNI - Analyst Report), Canadian Pacific Railroad (CP - Analyst Report), Norfolk Southern (NSC - Analyst Report) and Union Pacific (UNP - Analyst Report).

This bearishness should not surprise you given the current economic backdrop.

Carload Volumes Are Down

The global recession has dampened demand for various products, which in turn reduces shipments. According to the Association of American Railroads, U.S. carload volume is down 15.6% this year. Up north, Canadian railroads have seen volume fall 19%.

Lower volume has a twofold impact. First, it reduces overall revenues. Secondly, it makes it harder to maintain pricing power. The longer the recession lasts, the more likely it is that price competition will begin to emerge.

The biggest fear for the railroads right now is that prices could be forced lower, especially if the economy remains weak throughout the remainder of the year. Zacks Equity Research Transportation Analyst Ann Heffron believes that weaker pricing is a threat for the entire transportation sector.

(Ann has a long-term hold recommendation on all of the railroad stocks under her coverage.)

Fuel Costs Are A Double-Edged Sword

The previous decline in fuel prices was a positive since it partially helped to offset the lower volume by reducing costs. However, fuel prices have been rising recently. Oil, in particular, is up by more than 20% from its February lows.

At the same time, lower shipments make it more difficult for rail companies to charge fuel surcharges, which hurts their revenues. The best case scenario would be for oil to stay range-bound as any further increase could crimp margins.

BNI, CSX, NSC and UNP are Zacks #4 Rank ("sell") stocks. CNI and CP are Zacks #3 Rank ("hold") stocks. The Zacks Rank predicts relative performance for periods of 1-3 months.

Related ETFs

There is not an ETF that solely covers railroads. The closest is the iShares Dow Jones Transportation Average (IYT). BNI, UNP and NSC account for 3 of the fund's 5 largest holdings.

Zacks Premium and Zacks Elite subscribers can view the Zacks Industry Rank List at http://www.zacks.com/zrank/zrank_inds.php. This interactive list allows you to see all of the companies, and their Zacks Rank, within more than 200 industries. Shown below is the Zacks Sector Rank List, which shows the trend in estimate revisions on a broader scale.

Charles Rotblut, CFA, is the senior market analyst for Zacks.com. He can be reached at crotblut@zacks.com.