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Even though there is an air of optimism in the railroad space, mainly due to President Trump’s pro-coal stance, there are certain roadblocks that one must be mindful of before investing in the sector. Let’s take a look at some of the issues.

Eliminating the Clean Power Plan: Not Easy

In keeping with his promise to revive the coal industry, Trump recently inked an executive order to roll back the Clean Power Plan (CPP) – a major Environmental Protection Agency (EPA) initiative to regulate greenhouse gas emissions from power plants. Generally, any positive coal-related development is favorable for railroads, as coal is a key revenue-generating commodity for these companies.

However, we note that the executive order is not enough to repeal this plan and many market watchers believe that it will not be an easy task for the new administration to undo it. Not only will the process be extremely time consuming but will also require formulation of new rules. Many procedural and legal hurdles will have to be overcome before Obama’s signature climate policy is actually repealed.

Moreover, the desired amount of job additions following the scrapping of the CPP might not actually happen, according to several market watchers. Pera Forbes report, the share of coal in total electricity generation is projected to decline to 26% in 2040 from 33% in 2015, even without CPP. Moreover, a significant portion of the population will be subjected to health hazards if CPP is done away with.

Declining coal shipments have hurt the sector significantly in the recent past. This is evident by the below-par performances of key sector participants like Norfolk Southern Corp. (NSC - Free Report) , Canadian National Railways (CNI - Free Report) , Union Pacific Corp. (UNP - Free Report) and Canadian Pacific Railway (CP - Free Report) over the past few quarters. In the event of the above pro-coal development failing to materialize/achieve the desired results, the industry might continue to suffer.

Moreover, Trump’s proposal of 13% reduction in federal funding for transports in the 2018 budget may also hurt railroads. Many market watchers believe that the Chicago area would be badly hit if the proposals become a reality. This might harm railroads like Union Pacific. We note that Union Pacific currently serves five facilities in the Chicago area.

The Future of NAFTA to Affect Some Railroads

It is a fact that Trump’s victory in the U.S. presidential elections had boosted most U.S.-based railroad stocks. However, the same does not hold true for Kansas City Southern (KSU - Free Report) . This is mainly because of the company’s large Mexican exposure. The railroad, courtesy of its service networks across both the U.S. and Mexico border, dominates the primary rail networks between these countries.

However, Trump has threatened to terminate trade with Mexico. He has called the North American Free Trade Agreement (NAFTA) – the trade pact inked in 1994 between the U.S., Canada, and Mexico – a “disaster.” Trump has threatened to come down on companies that have production in Mexico and this, undoubtedly, is bad news for Kansas City Southern. He has also hinted at possibilities of renegotiating NAFTA. In the event of any unfavorable development regarding NAFTA, Union Pacific – which too has significantMexican exposure – may be hurt big time alongside Kansas City Southern. No wonder, investors interested in the railroad space keenly await updates on the NAFTA issue.

Kansas City Southern carries a Zacks Rank # 3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Other Headwinds

The State Transportation Board’s (STB) proposal of reciprocal switching - also referred to as forced access by the Association of American Railroads (AAR)-is a major headwind for railroads. In the event of things progressing as currently planned, some railroads may be forced to share their rail traffic with competitors. Consequently, the Association of American Railroads (AAR) is vehemently opposing the rules, calling them the violation of “the board’s governing statute, economic principles, and long-standing policy.”

According to AAR, this regulation might disrupt railroad operations, cause revenue losses as well as increase costs, hurting the bottom line. Moreover, according to the Intermodal Association of North America (IANA), intermodal volumes declined 2.1% year over year in 2016. This too is a cause for concern.

Zacks Industry Rank

The bearish Zacks Industry rank of 228 (out of 256 groups) carried by the Transportation-Rail Industry further highlights the fact that railroads will continue to face challenges, despite the optimism surrounding the space. The unfavorable rank places the companies in the bottom 11% of the Zacks industries.

Conclusion

The write-up clearly suggests that the railroads are not bereft of headwinds in spite of the optimism surrounding the space. The challenges can result in investors, especially the risk-averse ones, shying away from the sector.

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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