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Will Railroads Shine Brightly Despite Headwinds in Q3?

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It is a well-documented fact that railroads have performed well so far in 2017, driven by multiple tailwinds. In fact, the revival in the coal-related scenario has aided stocks in this space immensely. This is because coal is a key revenue generating commodity for railroads. Notably, coal accounts for more than 15% of revenues for railroads in the United States. Also, President Trump’s support for fossil fuels compared with the renewable energy is an added positive for the commodity.

In addition, a thriving and improving economy proves to be a boon for railroads as it implies that more goods are being transported across the United States via rail. Given the importance of this commodity for railroads, any positive coal-related development is expected to bode well for the sector.

Markedly, the revival of coal can be made out from the impressive performances of most sector participants with respect to the commodity in the second quarter of 2017. For example, at Union Pacific Corp. (UNP - Free Report) coal revenues (freight) increased 25%, while the same at CSX Corp. (CSX - Free Report) and Norfolk Southern Corp. (NSC - Free Report) improved 27% and 32%, respectively. The improvement in intermodal volumes is also a positive for railroads.

Moreover, Kansas City Southern (KSU - Free Report) , which is a key player in the same space, raised its quarterly dividend to 36 cents per share (annualized $1.44 per share) representing an increase of 9.1% over the previous payout. The likes of Canadian Pacific Railway Ltd. (CP - Free Report) and Canadian National Railway (CNI - Free Report) have raised their quarterly dividend payout this year as well, thus highlighting the financial prosperity of railroads.

Roadblocks to Watch Out for in Q3

Given this backdrop, the scenario looks bright for railroads in the third quarter of 2017. Despite the positives, the recent disruptions particularly those caused by Harvey might limit growth. In this regard, Union Pacific expects Harvey to hurt its bottom line to the tune of approximately 5 cents per share.

Furthermore, sluggishness pertaining to automotive volumes is an added concern for railroads in the to-be-reported quarter. With the automotive sector accounting for a significant chunk of their revenues, softness in automotive volumes are likely to hurt railroads significantly.

What’s in Store in Q3?

Despite the above-mentioned headwinds, we expect railroads to perform impressively in the third quarter on the bottom-line front. To counter the top-line woes, many railroads are looking to cut costs to drive their respective bottom lines. To this end, Union Pacific announced its decision to trim its workforce by up to 750 employees in August 2017, in a bid to increase efficiencies.

Also, Norfolk Southern is looking to cut costs in order to drive its bottom line. The company anticipates improving coal volumes to boost its third-quarter results.

While it is impossible to be sure about the exact nature of performance by railroads in the to-be-reported quarter, we expect stocks in this sector to perform impressively driven by the above-mentioned tailwinds despite the prevailing challenges.

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