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Soft Volumes Ruin Railroads' Q2 Earnings Show: What Next?

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It is no secret that the widely-diversified transportation space has been one of the worst-hit corners of the industry, thanks to the coronavirus pandemic. The travel restrictions and lockdowns imposed by the outbreak hurt stocks in the said domain immensely.

In this write-up, we present the second-quarter earnings performance of railroads, one of the key sections in the transportation space. We remind investors that declining overall volumes had earlier affected the results of railroads for the March quarter due to coronavirus-induced supply- chain disruptions. The coronavirus pandemic crippled the shipment of goods not only across the United States but globally.

In fact, the impact was more severe on the June quarter than on the March-quarter as the entire three-month period (April to June) bore the brunt of COVID-19-led chaos compared to only a single month (March) in the last reported quarter.

Against this backdrop, let’s recapitulate the released numbers of key railroad stocks this reporting cycle.

The second-quarter earnings season for the railroad space was kicked off by Kansas City Southern (KSU - Free Report) on Jul 17. This railroad operator, which currently carries a Zacks Rank #3 (Hold), reported an approximately 30% year-over-year decline in earnings due to softness in demand as a result of the ongoing coronavirus outbreak. Also, quarterly revenues of $547.9 million fell 23% due to weak volumes. Overall carload volumes plunged 21% year over year with unimpressive segmental performances.

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In a similar vein, Union Pacific Corporation (UNP - Free Report) reported a 20% contraction in business volumes, measured by total revenue carloads, in the June quarter. Weakness in the Bulk, Premium and Industrial units weighed on the overall volume picture. Due to coronavirus-induced depressed volumes, freight revenues — the primary contributor to the top line — dropped 24%.

Second-quarter revenues at CSX Corporation (CSX - Free Report) were down 26.3% due to coronavirus-triggered waning volumes. Segment-wise, merchandise volumes plummeted 22%. Coal volumes sank 44% due to lower domestic and export coal volumes. Moreover, intermodal volumes shrank 11% with both domestic and international volumes dwindling due to the pandemic-borne global economic gloom. In addition, revenues at another major U.S. railroad operator Norfolk Southern Corporation (NSC - Free Report) slumped 29% due to a 26% decrease in total volumes as a result of the prevalent economic downturn.

Amid this bleak revenue scenario that stemmed from suppressed volumes, the cost-cutting measures of railroads, however, provided some relief. For instance, operating expenses decreased 22% at Union Pacific in the June quarter. Similarly, operating costs declined 11.5% in the June quarter at Canadian Pacific Railway (CP - Free Report) . Consequently, the operating ratio (operating expenses as a percentage of revenues on an adjusted basis) — a key measure of profitability for stocks in the railroad industry — improved to 57% at Canadian Pacific from 58.4% in the year-ago quarter. Notably, a lower value of this key metric bodes well.

The Way Forward

With the re-opening of economies, volumes witnessed improvement but are still significantly lagging the year-ago levels. Per The Association of American Railroads’ data, total carloads for July 2020, though higher than the June reading, declined 17.6% year over year.

Despite this recent recovery, overall volumes are likely to remain stressed in the remainder of the year as the universal health peril seems relentless. Consequently, shipment of goods is likely to take a beating for some more time.  For instance, Union Pacific expects overall volumes to fall around 10% in the current year.

Notwithstanding the continued volume woes, the adoption of the precision scheduled railroading model by leading railroads like CSX, Norfolk Southern, Union Pacific and Canadian Pacific should lead to cost savings by increasing efficiencies. This, in turn, could partly offset the negative impact of diminished revenues as well as the overall volume concerns, at least in the near term.

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