Zacks Industry Outlook Highlights: CSX, Kansas City Southern, Union Pacific, Canadian National Railway and Norfolk Southern

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Aug 20, 2014, 09:30 ET

CHICAGO, Aug. 20, 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), Canadian National Railway Company (NYSE:CNI-Free Report) and Norfolk Southern Corp. (NYSE:NSC-Free Report).

Industry: Railroads

Link: http://www.zacks.com/commentary/33989/

Following second-quarter results, railroads appear to be on track to recovering from the operational hazards faced earlier this year. The industry's operational efficiency amid uncertain market conditions poises it for better times in the remainder of 2014.

Despite the projection of further headwinds for coal -- one of the major product shipments of rail -- the sector emerged strongly on infrastructural developments that supported natural gas, grain crop and petrochemical product shipments.

Zacks Industry Rank

Within the Zacks Industry classification, railroads are broadly grouped within Transportation (one of 16 Zacks sectors).

We rank all the 260-plus industries in the 16 Zacks sectors, based on the earnings outlook and fundamental strength of the constituent companies in each industry. To learn more, visit: About Zacks Industry Rank.

As a guideline, the outlook for industries with Zacks Industry Rank #88 and lower is Positive, between #89 and #176 is Neutral and #177 and higher is Negative.

The Zacks Industry Rank for the railroad industry is currently #8, implying that the outlook remains positive on this sector. This provides an encouraging outlook on the industry despite the persistent adverse seasonal impact that affects products of shipments. While some of the product lines see success or suffer, depending on seasonality or other external factors influencing market demand, intermodal remains on the growth trajectory.

We continue to be optimistic, as railroads are witnessing a gradual recovery in Coal shipments. Further, the upsurge in petrochemical shipments has bolstered this industry, thereby leading to earnings improvement.

Earnings Trend of the Sector

The broader Transportation sector, of which railroads are a part, reflects a sustainable growth trend. All the sector participants have reported second-quarter results, which have been stable in terms of both beat ratios (percentage of companies coming out with positive earnings surprises) and growth.

The earnings and revenues "beat ratio" for the quarter was 81.8% for the transportation sector. Total earnings for the companies in this sector rose 11.5%, while revenue growth was 0.5%, both on a year-over-year basis. The sector is expected to register full-year earnings growth of 13.2% in 2014. In terms of revenue expectation, the sector is expected to record 5.3%.

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

Second-Quarter 2014 Financial Results

The major companies that have so far reported include CSX Corp. (NYSE:CSX-Free Report), Kansas City Southern (NYSE:KSU-Free Report), Union Pacific Corporation (NYSE:UNP-Free Report), Canadian National Railway Company (NYSE:CNI-Free Report) and Norfolk Southern Corp. (NYSE:NSC-Free Report). All these companies' earnings were higher than the year-ago quarter figure and above market expectations as well. Significant growth across all commodity groups and a substantial improvement in operating ratio drove gains across most of the companies, supporting strong earnings this season.

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.

Railroads are now looking 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 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 Energy Information Administration's (EIA) reports, crude oil growth may go up to 10 million barrels per day from 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 with 0.03% in 2008 when the concept of crude by rail started gaining importance.

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,' railroads transported 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 due to 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, railroad companies are working toward tightening rail safety measures by appealing to federal regulators to phase out old tank cars if these are not upgraded. They are also seeking improved standards for new tank cars.

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