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Railroad Stocks in Trouble Over Lower Coal Shipments?

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It seems trouble is far from over for stocks in the railroad space. After Missouri-based Kansas City Southern (KSU - Free Report) withdrew its 2015 revenue and volume outlook at the Bank of America Merrill Lynch 2015 transportation conference, another railroad operator Union Pacific Corp. (UNP - Free Report) has painted a dismal picture with respect to coal shipments at the Wolfe research 8th annual global transportation conference.

Coal Shipments Suffer at Union Pacific

According to the Chief Financial Officer (Robert M. Knight Jr.) of the Omaha, NE-based company, Union Pacific coal shipments in the second quarter declined by 25% (data was considered till May 12). Even though coal shipments were expected to be weak, the magnitude of decline has added to the woes as it is much steeper than expected.

Last month, the company, while releasing its first-quarter 2015 results, had predicted coal volumes in the second quarter to decline in the mid-single-digit range. However, the performance has been worse so far in the second quarter. Union Pacific has attributed the weakness in domestic coal shipments to the softness in natural-gas prices, apart from inclement weather.

Moreover, Union Pacific is not hoping for much improvement. In fact, the company stated at the transportation conference that weak coal shipments will continue to hurt the company for the remainder of the year with no improvement in sight. Apart from the lackluster coal volumes, Union Pacific also said that volumes from its industrial products and agricultural products segments have declined 12% and 9% respectively in the second quarter till May 12.

The sole silver lining at the presentation came when Knight stated that the company’s performance in the second quarter will reflect the effects of operating efficiencies despite furloughing additional employees and placing more locomotives back in storage.

Kansas City Southern’s Warning

A week before the dismal picture revealed by Union Pacific, railroad operator Kansas City Southern had withdrawn its 2015 revenue and volume outlook at the Bank of America Merrill Lynch 2015 transportation conference. The company attributed its decision to the uncertainty shrouding energy-related markets, foreign exchange fluctuations and the volatility in U.S. fuel prices. The company stated at the conference that revenues from its energy segment have declined 50% and the number of carloads is down 38% so far in the second quarter of 2015.

The uncertainty prevailing in the energy markets also prompted the railroad operator to trim its capital spending target for 2015 to the range of $650 million to $670 million, from the earlier projected band of $700 million to $720 million.  

Weak Q1 for Railroads

Weak domestic coal shipments had led railroad stocks, primarily those based in the U.S., to perform disappointingly in the first quarter of 2015. Moreover, adverse foreign currency movements characterized by the strength of the U.S. dollar, lower fuel surcharges received from customers due to declining fuel costs and slow carload growth from the energy sector have hurt railroad stocks. The challenges have resulted in below-par first quarter 2015 results from main players in the space – Kansas City Southern, Norfolk Southern Corp. (NSC - Free Report) and CSX Corp. (CSX - Free Report) apart from Union Pacific.  

In fact, railroads have been the weak link amid the broader transportation sector as far as first quarter results are concerned. The sector has performed creditably in the first quarter of 2015 riding on strong performances of airlines, truckers and logistics providers. Stocks in the airline space have benefited the most from weak oil prices, as softness in fuel costs have resulted in massive reduction in operating expenses, thereby benefiting the bottom line.

Major airline stocks like American Airlines Group (AAL - Free Report) and Delta Air Lines, Inc. (DAL - Free Report) have reported higher than expected earnings in the first quarter riding on low fuel costs. Reduction in fuel costs has resulted in massive savings for these companies. With oil prices unlikely to touch the highs of last year any time soon, we expect airline companies to enjoy similar savings further over the near term. For instance, Delta projects low fuel costs to result in over $2 billion in savings this year.

Weak Oil Prices Blamed for Soft Coal Exports

According to the U.S. Energy Information Administration, coal exports have declined mainly due to weak fuel prices and soft global fuel demand. Increased output from other coal-exporting nations have also played spoilsport.

Even though oil prices have been displaying an upward trend lately, prices are nowhere near the highs witnessed in the first half of 2014. Crude prices have been hovering around the $60 a barrel mark. This represents a significant decline from the approximately $105 per barrel witnessed in July last year. In fact, oil prices have been fluctuating ever since it hit a 6-year low of under $44 in Mar 2015.

The Bottom Line

With coal shipments showing no signs of improving, as emphasized by Union Pacific’s comments, the U.S. railroad stocks, which have lost value significantly of late, seem to be bracing for tougher times ahead. In view of the prevalent weaknesses in the railroad space, we advise investors to avoid stocks such as Union Pacific, Kansas City Southern and Norfolk Southern Corp. at the moment, at least till the situation improves.  

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