It is a fact that declining coal shipments have hurt railroad stocks in the past few years. Given that coal is a key revenue-generating commodity for railroad operators, headwinds related to the commodity had affected sector participants big time. However, things are looking up for this key sector. Let’s find out why.
Trump Victory a Boon for Railroads?
The victory of President Trump in Nov 2016 turned into a blessing for the sector. This is because of Trump’s pro-coal stance and emphasis on the need to revive the coal industry. He even went on to say, “Coal will last for 1,000 years in this country.”
Coal is by far the most stable source of energy the U.S. produces, and the industry employs thousands of Americans. Given the President’s preference of fossil fuels over renewable energy, we expect a surge in the usage of coal during the Trump regime. Also, Trump advocates increasing jobs in the coal sector and possibly relaxing regulations. Additionally, increase in industrial production will lead to a rise in coal volumes.
Roll Back of Clean Power Plan
Keeping the promises made during the election campaigns, Trump recently inked an executive order to roll back the Clean Power Plan. The plan was introduced by President Obama in Aug 2015 to reduce carbon dioxide emissions from electricity by 32% from the 2005 level by 2030. Trump’s move is expected to usher in a new era in American energy and production as well as job creation, leading to greater prosperity.
Naturally, railroads like Union Pacific Corporation (UNP - Free Report) , Norfolk Southern Corp. (NSC - Free Report) and CSX Corp. (CSX - Free Report) stand to benefit substantially if the President successfully resurrects the coal industry. With the commodity accounting for approximately over 15% of the revenues for Class I railroads in the U.S., any positive development in this regard will support the industry.
In fact, the President had raised questions regarding climate change and its impact during his campaign as well. Trump, who views climate change as “a Chinese hoax” aimed at making U.S. manufacturing “non-competitive,” might pull out from the Paris climate deal, as well.
Will First-Quarter Results Improve?
Given the increase in coal demand, railroads might deliver a better performance in the first-quarter 2017 earnings season. Even in the fourth quarter of 2016, coal revenues at CSX Corp. – a key sector participant – surged 23% year over year to $551 million due to an 8% improvement in volumes. CSX currently has a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
The improving scenario with respect to coal can be gauged from the commentary provided by Union Pacific’s CFO, Rob Knight, at the 38th Raymond James Annual Institutional Investors Conference in March. Knight said that coal volumes at Union Pacific had improved 15% as of Feb 28. Volumes of agricultural products had improved 3%. Furthermore, Norfolk Southern anticipates coal volumes to increase in 2017 on the back of favorable conditions.
Apart from better coal volumes, efforts of railroads to control costs should drive bottom-line growth in the first quarter. Even in the fourth quarter, many railroads had reported improvements with respect to operating ratio (operating expenses as a percentage of revenues).For example, operating ratio at Kansas City Southern (KSU - Free Report) improved to 64.9% for full-year 2016 from 66.4%, recorded in 2015. We expect the trend to continue.
We also note that E. Hunter Harrison, CSX Corp.’s newly appointed CEO, intends to drive growth at the company by slashing costs. Harrison had adopted similar methods to drive growth at his previous company, Canadian Pacific Railway Limited (CP - Free Report) .
Investors prefer income generating stocks. Needless to say, companies that have a track record of consistent and incremental dividend payments are usually on investors’ radar.
Shareholders of major railroads have not been disappointed in this regard of late. Last year, Union Pacific hiked its quarterly dividend payout. Earlier this year, railroads like Canadian National Railway (CNI - Free Report) and Norfolk Southern did the same.
We are impressed with the company’s efforts to reward investors through share buybacks and dividend payouts. For example, Union Pacific returned around $5 billion to its stockholders in 2016 through these investor-friendly measures. Of the $5 billion, approximately $3.1 billion have been returned through share buybacks.
Apart from the likely improvement in coal prices, the inauguration of the expanded 102-year old Panama Canal last year bodes well for eastern railroads like Norfolk Southern. This is because container traffic at the ports on the East Coast is expected to increase. Historically, imports from Asia have followed the sea route up to the West Coast and were then transported by road to the East Coast.
Additionally, the decision of major railroads to invest significantly to promote safety and enhance productivity raises optimism. For instance, Union Pacific has announced a $3.1 billion capital plan for 2017. The scheme includes $300 million to further implement Positive Train Control. The plan is in line with the company's efforts to promote safety and enhance productivity.
The above analysis clearly suggests that things are looking up for the railroad industry. Better coal volumes, Trump’s pro-coal stance, industrial growth alongside improvement in intermodal volumes and pricing are likely to help the industry turn around.
Check out our latest Railroad Industry Outlook for more news on the current state of affairs in this market from an earnings perspective, and how the trend looks ahead for this important sector at the moment.
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