Weakness in domestic coal shipments has been hurting stocks in the railroad space for quite some time now. Since coal is a key revenue-generating commodity for railroad operators, it is only natural that the decline in domestic coal shipments has spelt significant doom in the space. The struggle faced by the railroad operators is evident from the 26.9% year-to-date decline witnessed in the Dow Jones U.S. Railroads Index.
Headwinds related to coal were primarily responsible for the below-par performances of railroad operators in the third quarter of 2015. Moreover, adverse foreign currency movements characterized by the strength of the U.S. dollar, lower fuel surcharges received from customers due to declining fuel costs and slow carload growth from the energy sector wreaked havoc for railroad stocks.
According to the U.S. Energy Information Administration, coal exports have declined mainly due to weak fuel prices and soft global fuel demand. Increased output from other coal-exporting nations have also not helped matters.
With the problem unlikely to be resolved any time soon, the path ahead for these companies looks a bumpy one. This was reflected in the disappointing outlooks issued by Kansas City Southern KSU and CSX Corp. CSX at the Credit Suisse industrial conference in Florida.
Gloomy Projections Hurt Stocks
Frank Lonegro, the Chief Financial Officer of Jacksonville, FL-based CSX Corp. presented a bleak picture at the conference stating that the decline in domestic coal shipments has been steeper than expected. The uncertainty prevailing in the energy markets have contributed to the current prevailing sorry state of affairs at the railroad operator.
The glum scenario prompted the company to forecast 2015 earnings per share growth at a mere 3% on a year-over-year basis. This presents a significant slash from the previous projection which had hinted at 2015 earnings growth in mid-single digits. The Zacks Consensus Estimate for 2015 currently stands at $2 per share, reflecting a 4.36% year-over-year decline. The company still expects to transport 30 million tons of export coal in 2015.
Lonegro apart, Michael W. Upchurch, the Executive Vice President – Finance and Chief Financial Officer of Missouri-based Kansas City Southern, also issued a disappointing outlook. Upchurch stated that the company expects revenues in the fourth quarter of 2015 to decline in high-single digits on a year–over-year basis.The Zacks Consensus Estimate for the fourth quarter currently stands at $622 million, reflecting a 3.3% year-over-year decline.
Moreover, revenues have already declined 7% (as of Nov 30) in the fourth quarter mainly due to adverse foreign currency movements and soft fuel prices in the U.S. Carloads have declined 3%, as of Nov 30, in the ongoing fourth quarter.
Upchurch also voiced a warning about intermodal growth at the conference. He stated that intermodal volumes, after starting off the quarter on a strong note, decelerated in November. The deceleration signals an end of the peak season.
The bleak projections caused shares of Kansas City Southern and CSX Corp. to decline 7.1% and 3.74% respectively on Dec 2. However, the effect of the disappointing outlooks was not limited to these two railroads alone. Other key players in the space like Union Pacific Corporation UNP and Norfolk Southern Corp. NSC also felt the heat, losing 2.75% and 2.81% respectively on Dec 2.
The struggles of the railroad operators were primarily responsible for the 2.12% slip in the Dow Jones Transportation Average index on Dec 2. The price-weighted index has declined over 12% year-to-date mainly due to the below-par performances of railroads.
In fact, Norfolk Southern, which recently received an unsolicited, low-premium, non-binding and highly conditional indication of interest from Canadian railroad operator Canadian Pacific Railway Limited CP, also stated at the conference that foreign exchange headwinds coupled with weak oil prices are hurting the demand for coal.
To Sum Up
There is no doubt that coal has turned into a splitting headache for railroad operators. While exports continue to be affected by the strong dollar, softness in the energy sector has encouraged utilities to switch to burning natural gas (which is much cheaper).
With declining coal shipments hurting the top line and the woes likely to continue for some time ahead, many railroad operators like Union Pacific are looking to control costs through measures like job cuts to drive bottom-line growth. While these are merely stopgap measures, how well the railroads manage to tackle the problem of coal weakness remains to be seen.
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