For Immediate Release
Chicago, IL – January 04, 2017 – Today, Zacks Equity Research discusses the Railroads, Part 3, including Kansas City Southern (NYSE: (KSU - Free Report) - Free Report ) , Norfolk Southern Corp. (NYSE: (NSC - Free Report) - Free Report ) , Canadian National Railways (NYSE: (CNI - Free Report) - Free Report ) , Union Pacific Corp. (NYSE: (UNP - Free Report) - Free Report ) and CSX Corp. (Nasdaq: (CSX - Free Report) - Free Report ).
Industry: Railroads, Part 3
Class 1 Railroads have been facing several challenges, such as declining oil prices and consumption, slow economic growth, low freight volumes and unfavorable weather conditions. Apart from the macroeconomic concerns, the industry is threatened by proposed regulations. However, Railroads have been lobbying against these regulations and the decision on its actual implementation has yet to be taken.
The main threat to Railroads is State Transportation Board’s (STB) proposal of reciprocal switching, which is also referred to as forced access by the Association of American Railroads (“AAR”). Per this proposal, shippers who do not have access to other modes of transportation will be allowed to use a competing rail line without any additional pricing and possibly at below market rates.
Per AAR, this regulation might disrupt railroad operations, cause revenue losses and overall increase costs for Railroads. Notably, the proposed regulation might cost Railroads almost $8 billion a year. Investments in development of railways are usually undertaken by the companies that own the respective networks. Reciprocal switching would result in these companies spending on infrastructural developments that can be used by competitors without paying sufficient returns in exchange.
Other proposals, such as reregulation of certain commodities and introducing a price cap for the amount charged by Railroads to shippers, are also major concerns for the industry. Railroads strongly believe that the operational complexity of railroads is bound to increase and revenues will suffer if such regulations are implemented. It would add to the woes of the industry, which is already struggling to restore bottom-line growth.
Low Intermodal Volumes and Pricing
An article published by the Journal of Commerce (“JOC”), mentioned that rail companies do not expect a rebound in intermodal volumes or pricing at least up to the second half of 2017. Per the Intermodal Association of North America (“IANA”) intermodal volumes declined 4.6% year over year in the third quarter of 2016, marking the second consecutive quarterly decline. Prior to the second quarter of 2016, intermodal volume growth had been inching up for the past 25 quarters.
Coal makes up for the bulk of revenues for Railroads. However, we note that this segment has been underperforming with the shift in focus to renewable energy, low industrial demand and cheaper natural gas. Most leading Railroads such as Kansas City Southern (NYSE: (KSU - Free Report) - Free Report ) , Norfolk Southern Corp. (NYSE: (NSC - Free Report) - Free Report ) , Canadian National Railways (NYSE: (CNI - Free Report) - Free Report ) , Union Pacific Corp. (NYSE: (UNP - Free Report) - Free Report ) and CSX Corp. (Nasdaq: (CSX - Free Report) - Free Report ) have seen revenues decline as a result.
There are chances, however, of coal being revived under President-elect Donald Trump. A strong supporter of clean coal, Trump is committed to increasing jobs and easing regulations for the industry, in turn, boosting coal volumes.
Despite the aforesaid positives, the cost of making coal clean is a huge setback. The technology, currently in use, significantly cuts emissions from coal into the environment but it is expensive. Thus, its economic feasibility and availability is something which would need to be addressed to see the desired increases in coal volumes.
Another energy commodity in the limelight is crude oil. Prices of this commodity are expected to improve significantly in 2017 as a result of OPEC members agreeing to cut production. However, the price movement will depend on the extent to which OPEC members actually cut output. Additionally, non-OPEC nations like Russia – a major producer – will also need to ensure that production is lowered, which could be a challenge for its government.
U.S. shale producers, on the other hand, might enter the markets again if crude oil prices increase. We note that these threats could result in lower-than-expected fuel surcharges and revenues for Railroads.
Railroads definitely have potential to grow in 2017. The companies probably faced their toughest few quarters in 2016. However, the major reason for concern is the uncertainty overshadowing each positive aspect that can drive growth. Agrarian products are expected to perform much better than prior years but adverse weather conditions remain a threat.
Trump’s tenure can result in better days for the industry, but that depends on his proposed changes being implemented. Most significantly, if proposed regulations like reciprocal switching are indeed put into effect, the industry will be exposed to a major overhaul and in the short-term results would be impacted. Overall, it remains to be seen the direction U.S. economy and government decisions take and how it ultimately shapes the next few quarters for Railroads.
Check out our latest Railroads 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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