The opening up of economies across the globe has left a positive impact on almost all industries. For the railroad industry, volumes have improved modestly from the lows in April. The Association of American Railroads’ (AAR) recently released rail traffic report for the week ended Jun 27 reflects this increase in volumes.

Carloads (volumes) declined 22.4% year over year to 794,256 in June but represents an increase from both April and May. Coal volumes decreased 34.1% in the month after having “stabilized at about 50,000 carloads per week by the end of June” following record low volumes in early May. The reopening of automotive plants in early June has increased loadings for metals, glass and plastics. Meanwhile carloads for farm products (excluding grain) increased 11.1% year over year.

The gradual volume recovery process which began in May accelerated in June, per John T. Gray, AAR Senior Vice President. Gray further added, “By the end of June, freight loadings had improved by about 60,000 carload and intermodal units weekly over where they had been in late April.”

Reduced Costs Aiding Railroads

While year-over-year decrease in volumes due to coronavirus-led factors such as global economic slowdown and supply chain disruptions are weighing on the top lines of railroad companies, benefits of the precision scheduled railroading model are helping in partly offsetting these adversities.
 
Despite volume declines affecting revenues, major railroad players namely Norfolk Southern Corporation (NSC Quick QuoteNSC - Free Report) and Union Pacific Corporation (UNP Quick QuoteUNP - Free Report) reported bottom-    line improvements in the first quarter of 2020 thanks to reduced costs owing to increased efficiency from the precision scheduled railroading (PSR) model. During the first quarter, Norfolk Southern reduced operating expenses (excluding the non-cash locomotive charge) by $202 million courtesy of increased efficiency. The company’s bottom line inched up 2.8% year over year in the period. With Union Pacific’s operating expenses contracting 10% year over year, its bottom line improved 11.4% in the first quarter. Moreover, increased operational efficiency led to a 7% decline in CSX Corporation’s (CSX Quick QuoteCSX - Free Report) operating expenses in the first quarter.

At an investor presentation last month, Kansas City Southern provided an update on the positive impacts of PSR and active cost management on its operations. In this weak volume scenario, the company has been able to absorb new volumes with minimal train and crew starts. Cost controls and PSR are also leading to efficiency gains across the organization. On the costs front, the company has been able to reduce transportation, mechanical and engineering expenses significantly in May from that in March.

Railroad Stocks Should be on Your Watch List

Amid coronavirus-led volume woes, benefits of the precision scheduled railroading model in the form of reduced costs, are keeping railroad players afloat. In such a scenario, gradual improvement in volumes is providing a boost to railroad stocks. Albeit at a slow pace, the uptrend in volumes is anticipated to continue as businesses scale up production following the coronavirus-induced slump. Against this backdrop, we believe investors should keep an eye on some notable railroad stocks.

3 Stocks to Watch Out For

The stocks mentioned below fall under the category of Class I railroads in the United States. Cost-cutting initiatives and the recent uptick in volumes should aid each of these Zacks Rank #3 (Hold) companies. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Kansas City Southern is a transportation holding company that has railroad investments in the United States, Mexico and Panama.

The company is benefiting from strong performance of the Chemical and Petroleum segment. Additionally, increased operational efficiency is driving bottom-line growth. The company’s operating ratio (operating expenses as a percentage of revenues), a key measure of railroad efficiency, is consistently improving. With the recent improvement in freight volumes, Kansas City Southern’s carloads improved 31% (as of Jun 21) after having bottomed in early May.

Norfolk Southern Corporation is primarily engaged in the rail transportation of raw material, intermediate products and finished goods, primarily in Southeast, East and Midwest United States.

The company’s operating ratio has improved consistently thanks to its constant efforts to streamline operations by curbing costs. Through the PSR model, the company aims to improve efficiency and enhance customer service. Following the implementation of this model in 2019, network efficiency of the Merchandise unit improved greatly owing to reduced circuity, train miles and train start. The benefits are expected to amplify with time.

Union Pacific Corporation provides rail transportation services across 23 states in the United States through its principal operating company, Union Pacific Railroad Company.

Amid coronavirus concerns, the surge in e-commerce boosted the company’s parcel business. With the health peril continuing unabated, the trend is likely to continue as people stay home and shop online even more. Additionally, cost-cutting initiatives should continue to drive the company’s bottom line, while simultaneously improving operating ratio.

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