U.S. railroads, Wall Street favorites for much of the past decade, are slumping into a bear market amid a three-way squeeze from plunging coal, crude-oil and grain shipments.
An index of the four largest publicly traded U.S. carriers has dropped 20 percent from its peak in November, paced by Kansas City Southern, as the companies struggle to offset the loss of volumes. They haven’t tumbled this much since 2011.
Those difficulties are likely to drag on, leading to the first annual industrywide earnings decline since 2009, as low natural gas prices sap coal demand, U.S. oil drilling slows and harvests return to normal after a record crop. That threatens to crimp a rally that made the group one of the top performers in the Standard & Poor’s 500 Index.
“It’s going to be a tough year,” David Vernon, a Sanford C. Bernstein & Co. analyst, said after publishing a note last week whose title predicted second-quarter profit reports that would be “Dark and Full of Terrors.”
Earnings per share for the largest U.S. railroads — the other three are Union Pacific, CSX and Norfolk Southern — will fall 0.6 percent in 2015, based on analysts’ estimates compiled by Bloomberg. Last year, they gained 19 percent. Analysts predict revenue will drop 2.8 percent this year after jumping 6.7 percent in 2014.
The dwindling volumes for coal, oil and grain are magnified in contrast with last year’s surges. Petroleum carloads, chiefly crude, are down 0.6 after 2014’s 13 percent increase. The other commodities are down even more; Union Pacific’s grain and coal declines are 10 percent and 17 percent, respectively.
Coal’s retreat is especially worrisome for investors because it’s the industry’s largest commodity, and the weakening demand may be permanent. Environmental regulation has squeezed the fuel, which many utilities can easily replace with cleaner-burning natural gas. Coal accounted for 18 percent of cargo for both Union Pacific and CSX.
“This group has had the whammy of coal and the whammy of grain,” said Michael Barr, a buy-side analyst with Neuberger Berman Group, which owns stock in the four major U.S. railroads. “It makes these reported numbers look really bad.”
The S&P 500 Railroads Index’s gain in the 10 years through 2014 beat the broader S&P 500 by more than sixfold. Profits were driven by productivity as companies invested to refurbish networks following deregulation. Pricing gains were outsized as old contracts were renegotiated based on improved service.
Efficiency gains will be harder to achieve in coming years after most of the rails have increased their operating margins to more than 30 percent. Core pricing has increased, but not as fast as the past pace.
Not all investors are so pessimistic.
The railroads are only in a temporary rough patch, said Paul Taylor, chief investment officer for BMO Asset Management in Toronto, which owns rail stocks. Rails continue to take business from trucks and have pricing power, which drives earnings over the long term, he said.
