Earnings Beat Galore At Railroads, Coal Still A Drag

The recently concluded first quarter of 2016 saw an improved performance from railroad operators, particularly with respect to the bottom line. The railroad space, which has been struggling for quite time now primarily due to coal-related headwinds, saw major players like Norfolk Southern Corp. (NYSE:NSC) , Kansas City Southern (NYSE:KSU) , Union Pacific Corp. (NYSE:UNP) , Genesee & Wyoming Inc. (NYSE:GWR) and Canadian National Railway Company (NYSE:CNI) report an earnings beat in the quarter.

This demonstrated a marked improvement over the disastrous 2015 performance from the sector .Declining coal shipments and a strong U.S. dollar had hurt railroad stocks in the preceding year, leading to a decline of over 30% in the Dow Jones U.S. Railroads Index.

Lowered Bar Facilitates Earnings Beats

Despite the multiple earnings beats in Q1, the ills plaguing the sector raise concern. In fact, we believe that the reason behind the bottom-line outperformance lies in the slashing of earnings estimates significantly following the luckless fourth-quarter releases. The downward revisions resulted in a highly conservative Zacks Consensus Estimate which made it easier for companies to record a beat.

To illustrate our point, let’s take a look at one of the largest railroad operators – Union Pacific. The first-quarter 2016 Zacks Consensus Estimate for this Omaha, Nebraska-based company was $1.09, down 23.8% from the comparable figure in the fourth quarter of 2015. No wonder the first quarter saw many railroad companies topping the significantly reduced Zacks Consensus Estimate.

Rail Traffic Data

Coal-related headwinds are here to stay, as has been highlighted by The American Railroads’ (AAR) latest U.S. rail traffic report (for the week ended May 14, 2016). Data from the report a 9.2% year-over-year decline in rail traffic (sum of total carloads and intermodal units). While total carloads for the week declined 11.4% to 238,353, intermodal volume was 260,026 containers and trailers, down 7.2% year over year. Six of the 10 carload groups posted weekly declines leading to the dismal picture with coal seeing the steepest fall of 30.8%.

The data also revealed a 14.2% decline in total carloads with coal emerging as the biggest laggard (33.9%) again. Overall rail traffic was down 8% year to date, with intermodal traffic declining 1.4%.

In view of this, it can be said that coal continues to be a cause of worry for railroad operators. While exports continue to be affected by the strong dollar, softness in the energy sector has compelled utilities to switch to natural gas (which is much cheaper).

Outlook Gloomy

That declining coal shipments will continue to hurt the railroad space can also be made out from the forecast unveiled by the Jacksonville, FL-based CSX Corp. (NASDAQ:CSX) at the Bank of America Merrill Lynch (NYSE:BAC) Transportation Conference earlier this month. The railroad operator expects volumes to decline in high-single digits in the second quarter.

The earlier guidance had called for a mid-to-high single digit decline. Worse-than-expected volume declines of various groups led by coal resulted in the below-par forecast. The company apprehends expects a 25% decline in coal volumes in 2016.

The above write-up clearly suggests that despite the series of earnings beats in the first quarter, challenges, particularly related to coal, are far from over for the railroad space.