Tuesday, December 12, 2023

Rail earnings on deck: What to expect

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Rail sector earnings season kicks off this month with companies likely to cite the impact of the extreme cold that hit much of the U.S. at the end of 2022.

“For the second consecutive quarter, overall rail volume growth fell short of our original expectation,” wrote Benchmark analyst Nathan Martin, in a note released Tuesday. Martin said the weather was a “significant driver,” noting that cold weather in December forced trains to go slower.

“Notably, we estimate Norfolk Southern was the only rail not to miss our prior 4Q volume growth estimate,” he added.

The weaker-than-expected volume environment has also been highlighted as an issue for the rail sector by Evercore analyst Jonathan Chappell.

Nonetheless, autos have performed well across the rail sector as dealers continue to restock and chip availability improves, according to Benchmark’s Martin. “As expected, grain volumes were strong; however, based on our conversations, could have been even better if not for heavy rains and port congestion in Western Canada,” he added. “The coal segment was also positive with export demand and domestic restocking driving growth.”

Related: Watch these rail stocks in 2023, says Evercore

“As for the stocks, we continue to prefer CSX, Norfolk Southern, and Union Pacific due to attractive relative valuation and potential service improvement-driven volume growth, although we acknowledge that a significant or prolonged slowdown in the economy could put pressure on the entire group,” Martin wrote.

The analyst firm raised its Norfolk Southern Corp.

price target to $280 from $250. Benchmark also raised its CSX Corp.

price target to $36 from $32 and raised its Union Pacific Corp.

price target to $240 from $220 and reiterated its buy rating for the three rail stocks.

Union Pacific reports its fourth-quarter results before market open on Jan. 24. Norfolk Southern reports its fourth-quarter results before market open on Jan. 25. and CSX reports its fourth-quarter results after market close that day.

Benchmark has a hold rating for Canadian Pacific Railway Ltd.

and Canadian National Railway Co.

Canadian National reports its fourth-quarter results after market close on Jan. 24 and Canadian Pacific reports its fourth-quarter results after market close on Jan. 31.

See: Low water levels along Mississippi River present a competitive opportunity for railroads, says analyst

Raymond James also raised its CSX price target to $36 from $33 and reiterated its outperform rating for the company on Monday. “CSX continues to execute its PSR initiatives that we expect will continue to drive operational improvement, translating to stronger revenues, margin, EPS, and FCF gains in coming years,” wrote Raymond James analyst Patrick Tyler Brown, in a note.

Precision Scheduled Railroading, or PSR, aims to make more efficient use of rail infrastructure by operating freight trains on a schedule, rather than waiting for a train to be built from a specific number of cars.

Raymond James also raised its Union Pacific price target to $244 from $220 and reiterated its strong buy rating for the company. “We remain enamored with Union Pacific’s (UP) implementation of Precision Scheduled Railroading (PSR) and focus on driving growth and improved service,” wrote Tyler Brown. “While PSR impacts are far-reaching, we are confident the network changes will yield a more profitable and reliable network by spinning assets faster and adhering to a tighter transportation plan.” 

The threat of a rail strike that hung over rail stocks for much of 2022 was removed in December when President Joe Biden signed a bill imposing a deal on rail-freight workers. With the union deal finally secured, rails are well positioned to capture price, according to Tyler Brown. “With greater than expected cost inflation coming from labor, the rails continue to message that they will be able to cover these costs (along with others) through continued pricing gains,” he wrote, in Monday’s note. “We believe that service begets volume, and that increased volume opportunities will allow for a greater level of pricing to be pushed through as we get through the cloudy macro.”

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