Zacks Industry Outlook Highlights: CSX Corp, Kansas City Southern, Union Pacific and Norfolk Southern

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Apr 28, 2014, 09:30 ET

CHICAGO, April 28, 2014 /PRNewswire/ -- Today, Zacks Equity Research discusses the Railroads, including CSX Corp. (NYSE:CSX-Free Report), Kansas City Southern (NYSE:KSU-Free Report), Union Pacific Corporation (NYSE:UNP-Free Report), and Norfolk Southern (NYSE:NSC-Free Report).

Industry: Railroads

Link: http://www.zacks.com/commentary/32309/railroad-stocks-navigate-a-choppy-track

The year 2014 set the railroads on a choppy track. Harsh winter weather had taken its toll on most of the freight transportation companies and railroads seem to be no exception. Operational efficiencies went down, while costs went up, leading some major railroads to lower their bottom-line expectations for 2014.

Earnings Trends of the Sector

The broader Transportation sector, of which railroads are part, reflects a sustainable growth trend. In the currently underway Q1 earnings season, 95% of the sector market capitalization have reported results, with total earnings up +7% on +3.3% higher revenues, with 66.7% beating EPS estimates and 33.3% beating revenue estimates. This is better performance than the broader S&P 500, but weaker than what we saw from the same group of companies in 2013 Q4 and the 4-quarter average.

Nevertheless, the sector is expected to register full-year earnings growth of 7.4% in 2014. In terms of revenue expectation, the sector is expected to register 4.4% growth.

For a detailed look at the earnings outlook for this sector and others, please read our weekly Earnings Trends report.

First Quarter 2014 Financial Results

The major companies that have so far reported includeCSX Corp. (NYSE:CSX-Free Report), Kansas City Southern (NYSE:KSU-Free Report) and Union Pacific Corporation (NYSE:UNP-Free Report). While Union Pacific and Kansas City reported year-over-year increases in earnings, CSX recorded a drop. However, year-over-year top-line growth has consistently been on the rise for these companies.

Major Contributors in 2014

Intermodal

While most of the other commodities including Automotive and General Merchandize have shown uncertainty in growth for 2014, Intermodal volumes are strong. As a result, we expect railroads to significantly focus on Intermodal expansion and tap underserved markets with highway-to-rail conversions. According to the Association of American Railroads (AAR), North American Rail Traffic was driven by 3.3% growth in Intermodal volumes in the first quarter. The growth was largely seen in U.S. intermodal business with volume expanding 3.8% year over year.

Railroads are now looking forward to the Mexican market, which is witnessing regulatory reforms, including rail reforms, initiated by President Enrique Peña Nieto to lure foreign direct investments to boost economy. Union Pacific, which serves all six gateways between the U.S. and Mexico, is likely to seek this opportunity to increase its penetration into the Mexican market.

Moreover, there are major investments to look forward to this year involving Intermodal growth. These include, BNSF Railway Company's $900 million spending on terminal, line and intermodal expansion and CSX Corp.'s investments in nine projects, Montreal terminal, capacity expansion of its northwest Ohio intermodal hub, and terminal expansion in New Orleans and Savannah.

Norfolk Southern (NYSE:NSC-Free Report) has an investment plan of $487 million on developing intermodal facilities that include six projects. Further, Kansas City Southern is looking forward to its Monterrey to Nuevo Laredo track upgrade and developing its double-track corridor between Sanchez and Nuevo Laredo. It is also expanding its Sanchez Yard and focusing on developments in Interpuerto San Luis Potosi.

Crude Shipment

According to the Energy Information Administration's (EIA) reports, crude oil growth may go up to 10 million barrels per day over a period of 2020 to 2040. Further, AAR reported that railroads transported 407,642 carloads of crude oil in 2013, up from 234,000 carloads in 2012. Further information suggests that crude oil accounted for around 1.4% of total Class carloads in 2013 compared to 0.03% in 2008 when the concept of crude by rail started gaining ground.

According to AAR, U.S. crude oil production will increase approximately 60% from 2008 through 2014, representing estimated production of 8.5 million barrels per day by 2014 end. This surge represents an opportunity for revenue accretion, which the railroads are trying to achieve with infrastructural development.

Despite the fact that rail-based crude transportation costs more ($10–$15 per barrel as against $5 a barrel through pipeline), crude shippers are compelled to rely on rail-based transport. This is due to the lack of pipeline infrastructural support in key oil and gas fields like Bakken Shale Formation in North Dakota and Montana, Eagle Ford Shale, Barnett Shale and Permian Basin in Texas, the Gulf of Mexico and Alberta oil sand fields in Canada.

As a result, inadequate pipeline developments have given rise to higher penetration of railroad transportation for crude oil shipping in these areas. According to AAR's article – Moving Crude Oil by Rail – railroad moved over 60% of North Dakota's crude oil production, which contains the vast majority of new rail crude oil originations.

Further, in terms of safety, railroads offer a better transportation avenue compared to pipeline given its better spill rate profile. According to U.S. Department of Transportation (DOT), spill rate for pipelines are three times higher than rail based on crude shipments between 2002 and 2012. Additionally, railroads are simultaneously working toward tightening rail safety measures by appealing federal regulators to phase out old tank cars if these are not upgraded. Railroads are also seeking improved standards for new tank cars.

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