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

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Aug 29, 2013, 09:30 ET

CHICAGO, Aug. 29, 2013 /PRNewswire/ -- Today, Zacks Equity Research discusses the U.S. Railroads, including Kansas City Southern (NYSE:KSU-Free Report), Canadian National Railway Company (NYSE:CNI-Free Report), Canadian Pacific Railway Ltd. (NYSE:CP-Free Report),CSX Corp. (NYSE:CSX-Free Report) and Norfolk Southern Corp. (NYSE:NSC-Free Report).

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Industry: Railroads

Link: http://www.zacks.com/commentary/28774/Railroad-Industry-Stock-Outlook--- AugSep-2013

Going by the quarterly performance of the class 1 railroad, we see volume growth from most of these carriers. Most of the carriers including Kansas City Southern (NYSE:KSU-Free Report), Canadian National Railway Company (NYSE:CNI-Free Report), Canadian Pacific Railway Ltd. (NYSE:CP-Free Report),CSX Corp. (NYSE:CSX-Free Report) and Norfolk Southern Corp. (NYSE:NSC-Free Report) showed modest volume growth.

Volume growth aided year-year-year top-line improvement the in all but Norfolk Southern. Despite a modest volume growth, Norfolk Southern was down year over year and missed the Zacks Consensus Estimate. While most of the class 1 railroads generated higher bottom line results beating earnings estimates, Norfolk Southern lagged year over year and failed to meet our expectation.

The primary catalyst to this bottom-line performance for most of the carriers was operational efficiency even in times of low market demand. Rising employee productivity, deployment of fuel-efficient locomotives and undertaking railroad safety measures were some of the key drivers of profitability even in adverse market conditions.

Rail carriers like Canadian Pacific recorded operating ratio improvement of 1,060 basis points year over year. Continued focus on maintaining asset efficiencies, safety measures and increased productivity have been the prime contributors to Canadian Pacific's success in the second quarter. There are several other near-term growth catalysts in the railroad industry.

Rising Contribution of Petroleum Product Shipment

According to the AAR report, rail traffic from petroleum products has seen a whopping 38% growth in the first six months. According to the Energy Information Administration's (EIA) reports, U.S. crude oil reached 7.5 million barrels per day production in Jul 2013, representing record growth since the last two decades.

On average, EIA expects crude oil growth at around 7.4 million to 8.2 million barrels per day, suggesting a stable market condition. This growth may go up to 10 million barrels per day over a period of 2020 to 2040, according to EIA reports.

As a result, this surge represents an opportunity for revenue accretion, which the railroads are trying to achieve with infrastructural development. According to industry sources, the role of crude oil as a revenue contributor has grown by leaps and bounds in a four-year span from a mere 3% to 30% of the oil and petroleum products shipment by railroads.

Despite the fact that rail-based crude transportation costs five times more ($10–$15 per barrel), 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 railroads transportation for crude oil shipping in these areas. According to reports, rail-loading capacity is expected to grow to 200,000 b/d by 2013 for crude oil shipments from Western Canada.

Major railroad companies like Norfolk are seeking expansion strategies fueled mostly by the development of the energy sector, including the gas exploration projects in Marcellus and Utica shale plays as well as ventures associated with coal and power generation. Over the coming years, the company plans to introduce 32 energy-related projects in 14 states under its service areas.

Another railroad company, Canadian Pacific projects crude shipment to reach up to 70,000 oil-tank cars by the year end and move to 140,000 by the end of 2015. In the coming days, we expect railroads to accelerate their investments in order to create adequate service capacity for the oil and gas markets resulting in exponential growth in crude oil shipments across the rail industry. Consequently, we expect petroleum shipments to remain favorable and emerge as a significant revenue contributor in the long term.

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