Railroads On Track With Profits Despite Economic ConcernsBY VANCE CARIAGA
INVESTOR''S BUSINESS DAILYThe 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. 22Much 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."