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Railroads: A Turnaround in Sight?

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Opinions remain mixed among analysts and industry decision makers on whether the Railroads industry will shift towards a growth trajectory. While some believe that earnings have bottomed, others feel that unprecedented economic woes will likely continue to impede growth. However, post earnings season, a string of factors can be evaluated to speculate that a positive turn might be on the cards for this industry.

Expected Increase in Grain Production & Intermodal Volume

The agricultural segment is expected to support growth for railroad companies that would follow a period of declining volumes as a result of lower grain production in Canada and the U.S. But hopes remain high that the coming crop size in Canada and the U.S. will be the 5-year average, which should be beneficial to the railroad industry.

Another segment to consider is Intermodal which accounts for the bulk of revenues for most railroad companies. This segment has also been a drag of late. However, the positive outlook issued by the Intermodal Association of North America (“IANA”) signals at an increase in volumes in 2016. IANA expects intermodal volumes to increase by 3–4% in 2016.

As per a Journal of Commerce (“JOC”) article, intermodal volumes inched up 2% in the first quarter of 2016 compared to the same period in 2015. An increase in intermodal volumes can help railroad operators offset revenue losses stemming from the weak coal and energy segments. Notably, within intermodal, imports are a key factor driving growth.

Class I Railroads: Outlook & Investments

Investments in a sector are always a solid indication of future projections by company management. Some of the major railroad companies have made commendable investments in the sector this year and there are several more in the pipeline.

Union Pacific recently invested over $150 million in the development of its rail infrastructure in regions such as Oregon, Nevada, Wyoming, Utah and Washington. The investments are part of the company’s total planned capital expenditure of $3.75 billion for this year. Notably, the company has spent almost $33 billion in the past decade which has resulted in a 25% decrease in derailments.

Meanwhile, Norfolk Southern Corp (NSC - Free Report) has planned investments of $2.1 billion this year for rail safety network enhancements, operational efficiency improvement and growth opportunities. Canadian Pacific is targeting an investment of approximately C$2.75 billion this year as part of its capital program, out of which C$1.5 billion is for the enhancement of track infrastructure.

According to a Maquila Portal report, Kansas City Southern (KSU - Free Report) intends to put in $154 million in Sanchez, Nuevo Laredo Backyard, in Tamaulipas in railway infrastructure and modifications, expansion of Interpuerto facilities, track maintenance, and new equipment and systems. Mexican operations account for a bulk of Kansas City Southern’s revenues.

CSX Corp (CSX - Free Report) recently raised its capital investments projection for 2016 by $300 million to $2.7 billion to include accelerated payments for locomotives throughout 2016.

Although investments have declined slightly for some companies as compared to the previous year, the fact that companies are still opting to make sizable investments is encouraging.

Expansion of Panama Canal

The expansion of the 102-year old Panama Canal in June, in order to let huge container ships carrying upto 14,000 containers to navigate across it, initially raised concerns for railroads. Although it does hold that volumes for railroads transporting freight between the U.S. west to east coast might get affected, the enhanced Panama Canal might actually favor companies with extensive operations on the U.S. east coast and those shipping to the Gulf Coast.

Companies expected to benefit from the Panama Canal expansion include Norfolk Southern, CSX Corp., Canadian National (CNI - Free Report) and Canadian Pacific. Moreover, the canal expansion might eventually lead to higher shipments to ports along the coast but only if economic conditions in the U.S. improve.

Rebound in the Cards?

It cannot be said for certain if the railroad industry can actually start seeing earnings growth over the next few quarters. One of the key reasons for the uncertainty is economic factors which give no clear indication on where the economy is headed. The Fed continues to hold rates at the current level despite signaling at the prospects of a hike.

Meanwhile, events such as Brexit, slowdown in the Chinese economy, low oil prices and a tepid growth in emerging economies have kept markets in turmoil this year. However, a favorable U.S. job report, possible uptick in industrial growth and rise in domestic consumption may provide the much-needed boost to the economy, thus propelling growth in industries such as railroads.

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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