Thursday, January 14, 2016

Jason Seidl: Notable changes at NS; recession fears grip CSX shares

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Norfolk Southern’s Jan. 12, 2015 announcement about consolidating its Pocahontas and Virginia divisions “is notable,” and CSX is facing “continued industrial challenges,” according to Cowen and Company Managing Director and Railway Age Wall Street Contributing Editor Jason Seidl.

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“NS still remains a top rail pick along with Genesee & Wyoming and CN,” said Seidl. “We think NS will have a floor in it for now as Canadian Pacific is unlikely to back away anytime soon. This announcement, like the ones in the recent past, show that NS is committed to improving its operating ratio and service levels at a time when the business mix is changing rapidly.”

This shows that NS “first, is very much committed to driving operational and margin enhancing efficiencies across the network as it follows several other changes in recent months,” said Seidl. “These changes include shuttering Triple Crown and eliminating a corporate office. Second, it speaks to the continued loss of coal business out of West Virginia, which will likely continue for the foreseeable future. We don’t believe these changes are tied to the CP bid for NS and in fact can potentially make the case for an acquisition more difficult, on the margin. As NS continues to make operational improvements, raise service levels and subsequently elevate its OR, the company could face less pressure from shareholders looking to sell to CP. Third, changes like these reinforce our view that NS remains a top pick in our rail coverage. We believe it has the ability to grow EPS the most out of the Class I’s in 2016 as $82 million in certain weather and service-related one-time expenses through 3Q15 disappear. We still think headcount at the company is elevated and likely to come down, which will lend support to the bottom line. We also expect CP’s bid will keep a floor in the stock.”

For CSX, “Industrial headwinds are likely to persist, potentially even intensifying somewhat in the case of export coal,” noted Seidl. “Pricing was one of the few bright spots in the quarter, but we believe it will moderate from this point as intermodal will be forced to reckon with soft truckload rates. Investors will likely begin to look at 2017 for material improvement in fundamentals.”

“CSX reported solid 4Q15 results given a challenging environment,” said Seidl. “Looking out to 2016, however, we see very few bright spots, especially in the first half. The combination of a strong U.S. dollar and global economic softness is likely to continue to weigh on demand for U.S. steel and export coal and grain. Low natural gas prices and elevated inventory stockpiles could pressure domestic coal demand further, and low energy prices continue to hurt crude-by-rail economics. On the intermodal front, low diesel prices and abundant truckload capacity should slow conversion from the highway, and international intermodal remains challenged. CSX guided for an earnings decline in 2016, compared to our and Street expectations at the time of the earnings release of modest 2% earnings growth.

“Total core pricing came in at a solid 4.1%, but represented a moderation from 4.6% in 3Q15. Merchandise and intermodal pricing was 4.5%, slightly better than the 4.4% recorded in 3Q15. While the overall pricing result is solid, we are somewhat concerned that it appears to have been driven in good part by intermodal, an area likely to face deteriorating pricing going forward. As such, we believe 3Q15 may have represented a peak in year-over-year contractual increases, and we would look for the all-in pricing metric to continue to moderate throughout 2016, as the impacts of low truckload rates and abundant capacity on intermodal demand should become more pronounced in coming quarters, in our opinion. That said, as more of the highly fragmented TL (truckload) market gradually complies with ELD (Electronic Logging Device) regulations, and as carriers seize their fleet growth, TL rates could begin to recover in 2017, driving rail intermodal pricing.”

“We are lowering our 2016 EPS estimate to $1.80 from $2.00 to reflect further weakness in coal and crude oil and an overall sluggish macro environment,” said Seidl.” Our new estimate reflects a 1.7% traffic decline and a 70.3% OR. We are also introducing our 2017 EPS estimate of $1.95, which reflects largely flat traffic and a 69.5% OR.”

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