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Volume Woes Likely to Hamper Railroads' Q2 Results: Here's Why

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It is common knowledge that the widely-diversified transportation space has been one of the hard-hit corners of the industry, thanks to the coronavirus pandemic. The COVID-19-induced travel restrictions and lockdowns hurt stocks in the said space immensely. These palpable struggles are further validated by the Zacks Transportation sector’s loss of 9.7% since the start of February.

In this write-up, we examine the prospects of railroads, one of the key corners in the transportation space, in the upcoming second-quarter earnings season.
The coronavirus pandemic crippled the shipment of goods not only across the United States but globally. This, in turn, dented the overall volumes in the first quarter of 2020. Evidently, Norfolk Southern (NSC - Free Report) , currently carrying a Zacks Rank #3 (Hold), reported an 11% drop in total volumes due to weak energy prices and the COVID-19 outbreak. Moreover, the likes of CSX Corporation (CSX - Free Report) withdrew its financial outlook for 2020 due to the coronavirus-related uncertainty.

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The second-quarter earnings season for the railroad space will be kicked off by Kansas City Southern (KSU - Free Report) on Jul 17. We expect the industry participants to persistently suffer in the second quarter due to poor volumes. This is because the global health peril continues to pose a threat. Moreover, the recent spike in cases across the United States heightened fears of a second wave of the dreaded virus with the U.S. economy reopening.

The fact that railroads will carry on with the negative trend in the impending second-quarter reporting cycle due to volume contraction is evident from the bearish projections provided by both Kansas City Southern and Union Pacific Corporation (UNP - Free Report) .

Management at Kansas City Southern recently stated that second-quarter volumes plunged 23% as of Jun 21. Overall, the top line too declined 24% as of Jun 21. Even though carloads improved recently, the same is still 8% below the pre-coronavirus levels.  

In the same vein, Jennifer Hamann, Union Pacific’s chief financial officer, recently stated that overall volumes for the June quarter decreased 22% on a year-over-year basis (through Jun 2, 2020). This unfavorable reading can be primarily attributed to double-digit declines in volumes at the Bulk (Grain & grain products, Fertilizer, Food & refrigerated, Coal & renewables: down 16%), Premium (down 29%) and Industrial divisions (down 17%).

Due to the coronavirus-induced supply-chain disruptions and closure of the U.S. automotive plants, Hamann said that the overall volume dip at Union Pacific is estimated to be nearly 20% in the June quarter. Hamann further added that that the operating ratio (operating expenses as a % of revenues) — a key measure of profitability for stocks in the railroad industry — will not recover in the second quarter on a year-over-year basis due to the downbeat volume view. Also, Norfolk Southern spokesperson anticipates the adversities from coronavirus pandemic to affect its second-quarter performance significantly (volumes slumped as much as 30% in April). The company expects volumes to dwindle across all segments.

Amid this dismal volume-related scenario, the cost-cutting measures undertaken by railroads should provide some relief and boost the bottom lines in the June quarter. Evidently, Kansas City Southern undertook several cost-reduction initiatives in the first half of 2020 like limiting the backfills of open positions. Moreover, the adoption of the precision scheduled railroading model by railroads like CSX, Norfolk Southern, Union Pacific and Canadian Pacific Railway (CP - Free Report) should lead to cost savings by increasing efficiencies. This, in turn, could partly offset the negative impact of shrinking revenues as well as overall volume depletion in second-quarter 2020.

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