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Tuesday, September 05, 2017

Investor concerns may be overblown: Cowen and Company

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Cowen and Company Managing Director Jason Seidl Cowen and Company Managing Director Jason Seidl

Cowen and Company is “not as concerned as many investors are about slowing volume growth,” says Managing Director and Railway Age Wall Street Contributing Editor Jason Seidl. Though North American Class I carloads have been down for each of the past two years, volumes “have snapped back through August,” up 5% year-to-date.

Cowen has heard from many investors who are concerned about the recent growth slowdown that appears will last through year-end. “Their view is that we could be headed back down a multi-year path of limited volume growth, or worse, declines,” says Seidl. However, after analyzing the data, Cowen found that about two-thirds of rail revenue growth over the past ten years has been due to yield, and and one-third is due to volume. “And with half of the six public Class I equities significantly outperforming the market this year, we appreciate the concerns, but for longer term investors we think it’s best to stay focused on pricing trends, as they have been the key driver over extended periods of time.”

Cowen expects pricing to remain above rail inflation and trend higher after last year’s bottoming. “Recent conversations with private industry executives suggest intermodal pricing has increased, in some cases materially over the past two weeks,” notes Seidl. Cowen’s Second-Quarter 2017 Rail Shipper Survey indicates shippers are expecting accelerating rate increases over the next 6-12 months. Tightening truckload capacity from the fast-approaching ELD (Electronic Logging Device) regulation “is likely to drive rail rates higher as well.”

CSX’s customer service disruptions could be affecting that railroad’s ability to take advantage of pricing, and this is a concern, Seidl points out. Overall pricing remained fairly solid in second-quarter 2017, “but continued to show sequential moderation,” he says. “All-in same-store pricing was 3.7%, compared to 3.9% in first-quarter 2017. Merchandise and intermodal pricing was 2.2%, compared to 2.5% in first-quarter 2017. This occurred at a time when overall rail industry pricing is stabilizing and showing positive signs.”

In its second-quarter earnings call, trucker J.B. Hunt alluded to the railroads raising prices. Cowen’s second-quarter 2017 Rail Shipper Survey showed an increase in rail shipper pricing expectations compared to the first-quarter survey.

In a CSX-specific survey Cowen released on Aug. 1, more than 80% of respondents said they had experienced service issues since the railroad began to implement CEO Hunter Harrison’s Precision Scheduled Railroading operating model. Nearly 40% of those responding to the survey had switched some business to Norfolk Southern; 67% had transferred freight to a trucker. “Our recent channel checks suggest that this dynamic may have continued throughout August,” Seidl notes. “We expect NS to show additional market share gains with solid pricing in third-quarter 2017. We think NS’s second-half EPS could increase by 5% if they take 5% of CSX’s traffic over that time frame.”