(The following story by Vance Cariaga appeared on the Investor’s Business Daily website on February 28.)
The recent rebound in railroad stocks is as much about expectations as anything else.
Expectations for the sector were pretty low in late December and early January, when worries over a looming recession and weakness in key end markets led many investors to bail out.
The 12 stocks in IBD’s railroad group slid 17% over several weeks before hitting a five-month low on Jan. 22.
Much of the sell-off was tied to an overall slump in the broader markets, analysts say. But part of it was specific to the rail industry.
“You had this combination of all these horrible things tied to rail: the downturn in housing and retail, which are very much rail-related, slumps in the furniture and automotive markets,” said Anthony Hatch, an independent railroad analyst for ABH Consulting in New York.
Those horrible things haven’t gone away over the past month. The only thing that’s changed is Wall Street’s attitude toward rail stocks. Even after a two-day selloff, the group is up 24% since its January bottom and hit an all-time high on Tuesday.
Gains have been reported across the board. CSX (CSX) also set a new peak on Tuesday and is up almost 27% from its January low.
Similarly robust increases have been posted by Canadian Pacific, (CP) Kansas City Southern, (KSU) Norfolk Southern, (NSC) Canadian National Railway, (CNI) Union Pacific (UNP) and Burlington Northern Santa Fe. (BNI)
Pleasant Surprises
The stock turnaround is partly the result of calmed nerves, Hatch says. He cites a string of solid earnings reports, which helped restore confidence in the sector.
“People lowered their expectations of rail stocks due to the economy, but these companies consistently produce upside earnings surprises,” he said.
Each of the seven major railroad stocks topped fourth-quarter earnings estimates, some by a wide margin. Each also grew earnings year over year. That’s something rival freight haulers — including many top trucking firms — didn’t do.
One of the rail sector’s advantages is its deep ties to markets that are doing well right now, including grains, coal and chemicals.
The wild card is whether those markets are enough to offset some of the industry’s nagging problems, including the threat of flat or declining carload volumes.
It’s a particular risk in the intermodal sector, which uses a combination of trains and trucks to move imported goods from port cities to the rest of the continent.
Overall carload volume in the rail industry was down about 1% during the first seven weeks of the year, says Citigroup analyst John Kartsonas.
He expects volumes to be flat this year amid a continued decline in imports. As U.S. consumers scale back on spending, retailers order fewer goods from foreign suppliers. The result is less intermodal business, which drove the rail industry’s growth over the past three years.
“We began to see our first negative volumes in August,” Kartsonas said. “If the retailers are not willing to buy a lot, it has very negative effect on imports and intermodal.”
Imports to the Port of Los Angeles hit a high of 8.5 million containers in 2006, but slipped to 8.4 million in 2007. Much of the slowdown has been in goods coming from China.
Some railroads are better positioned than others to weather the economic crunch, analysts say.
“Given where we are in the economic cycle, we continue to favor less cyclical railroads with higher exposure to the ‘holy trinity’ of freight: agriculture, coal and intermodal,” Longbow Research analyst Lee Klaskow wrote in a Feb. 21 industry report.
He cites Burlington Northern, Canadian Pacific and Norfolk Southern as having the strongest positions in those markets.
Most analysts see sluggish top-line growth in the near term. The top railroad stocks are expected to grow revenue in the mid-single digits this year. That’s about the same as last year but down from 2006, when six of the top seven players grew revenue in double digits.
“I wouldn’t expect to see any major upside revenue surprises,” Kartsonas said. “I would say any surprise would come on the downside rather than the upside the way economy shaping up.”
He also downplays the sector’s ability to beat profit views, saying cost efficiencies have played a big part.
“You want an environment where you see strong earnings growth because of fundamentals, not because you’re able to save a lot here and there,” Kartsonas said.
Still, Hatch says the fact that rail operators are able to grow at all is a testament to the sector’s competitiveness in an increasingly tough market.
“The railroads are growing in importance in terms of market share,” he said. “The trucking competition has a lot of issues: labor turnover, road congestion, the high cost of fuel. Whenever you can gain market share in this type of environment it’s a positive.”