By Nick Carey and Sinead Carew
CHICAGO/NEW YORK, Sept 28 (Reuters) - Investors in U.S.
railroad stocks, who have been punished in 2015 by an
accelerating decline in high-margin coal shipments, now are
pinning their long-term hopes on a resurgence in consumer
spending.
Their bet is that a strengthening economy will produce
enough demand that railroads will be able to replace the income
lost to years of declining coal use with so-called intermodal
shipping - the movement of containers stuffed with clothing,
furniture and other consumer goods.
Thanks to environmental rules regulating power plant
emissions, coal use has declined steadily since peaking in 2008.
So far this year, freight volumes have tumbled 9.2 percent
as low energy prices encouraged utilities to switch to burning
cheaper natural gas, while the strong U.S. dollar has hurt
exports. The accelerated decline this year has highlighted
expectations that barring regulatory changes, railroads' revenue
from coal should continue to decline.
Railroad shares have plunged as a result. The Dow Jones U.S.
Railroads index has pulled back 27.9 percent this year after
rising 39.7 percent in 2013 and 28.9 percent in 2014. The
railroads' decline has contributed to a 14-percent year-to-date
decline for the broader Dow Jones transportation average .DJT .
The major publicly-traded U.S. railroads including Union
Pacific Corp UNP.N , CSX Corp (NYSE:CSX) CSX.N and Norfolk Southern Corp (NYSE:NSC)
NSC.N have missed estimates or trimmed earnings forecasts,
furloughed workers and parked equipment, largely as a result of
the coal downturn.
"All that coal is not coming back," said Morningstar analyst
Keith Schoonmaker. "The question is how much (consumer goods)
can mitigate those declines."
It is an open question. Intermodal freight volumes are more
than double coal and make up 47 percent of total rail traffic,
according to the American Association of Railroads, but that is
a low-margin business where revenue per carload is often half or
less than coal.
And though intermodal shipments have risen more than 17
percent since 2008, the moderate 3.1 percent increase in
intermodal freight shipments so far this year has not been
nearly enough to offset coal revenue declines.
If the economy and consumer spending hit a consistent stride
in 2016, that would lift intermodal shipments - perhaps enough
to beat 2015 volumes. But with consumer spending on goods and
services expected to rise just 2.8 percent in 2016, according to
the Congressional Budget Office, it will likely take years to
offset coal's decline.
"If economic growth can pick up, the rails will look like a
bargain," said BB&T (NYSE:BBT) Capital Markets analyst Mark Levin.
Wall Street consensus shows aggregate earnings returning to
more than 9-percent growth in the first half of 2016, according
to Thomson Reuters data. But part of that improvement will
likely be because of a comparison with weak 2015 numbers.
The group is seen posting an earnings decline of 8.3 percent
in the third quarter, according to Thomson Reuters data.
The 2016 earnings estimates may need to come down. Macquarie
Research analyst Cleo Zagrean says, "the commodity environment
remains bleak" and U.S. utilities may switch to natural gas at a
faster pace than investors expect in coming years.
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Railroad revenue by freight sector
http://reut.rs/1LhnkC4
Railroad coal carloads versus intermodal carloads
http://reut.rs/1LhnkC4
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COAL BURNOUT
All of the major publicly traded U.S. railroads have
experienced double-digit declines in coal shipments and revenues
since 2008.
CSX, the most exposed with 21 percent of second quarter
revenue coming from coal shipments, has seen coal shipments
decline 30 percent since 2008. Its share price has fallen 26.8
percent this year. Norfolk Southern's coal carloads have fallen
and 28 percent while Union Pacific (NYSE:UNP) coal carloads have fallen
nearly 25 percent in the same time frame. Norfolk Southern
shares are down 31 percent so far this year while Union Pacific
shares have fallen 27.3 percent.
Railroad executives have expressed hope consumers will help
lift intermodal in the year ahead.
"Where we're doing better are the consumer-driven things,"
Norfolk Southern chief financial officer Marta Stewart told a
Citibank investor conference this month. "We think that's going
to continue into 2016."