Monday, April 10, 2017

Cowen: First-quarter surveys cautiously optimistic

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

Cowen and Company’s First-quarter Rail Shipper and Rail Equipment Surveys indicate general optimism about a business environment that appears to be recovering and is “slightly positive” for railroads, say Managing Director and Railway Age Wall Street Contributing Editor Jason Seidl and ‎Vice President Equity Research Matt Elkott.

First-Quarter Rail Shipper Survey

Shippers are anticipating rail price increases of 2.6% over the next 6-12 months, down from 2.7% in Cowen’s 4Q16 survey. “Shippers remain confident in the economy and their business’ growth prospects,” says Matt Elkott. “We think rail took share from TL (truckload) in 1Q17. Overall, the survey is slightly positive for the rails, in our view.”

The average base rate increase of 2.6% is down 10bps (basis points) sequentially from our 4Q16 survey,” says Elkott. That’s more than the 2.1% investors are expecting based on our recent investor sentiment survey. Railroads have likely been taking market share from trucks over the past three months, as 20% of intermodal shippers moved freight from the highway to the rails in 1Q17 vs. 8% in 4Q16. It’s a similar story on the bulk/carload side, as 30% have shifted to the rails from the road vs. 21% last quarter.”

Rail pricing “is likely still under some pressure,” notes Elkott. “Not only are expectations from shippers subdued again, but fewer of them said truck prices are cheaper than rail in this survey. 37% said their trucking options were less expensive than their intermodal options in 4Q16, but in 1Q17 that fell to 26%. The story is similar for bulk shippers. More competitive rail pricing could cause some margin pressure in 1Q17.”

Interestingly, “only 16% of shippers surveyed view Hunter Harrison’s new role as CEO of CSX as positive for their businesses,” says Elkott. “Of those that view the hire positively, 60% expect his leadership to result in a more efficient railroad.”

In conclusion, Elkott notes that respondents said that “ business trends are improving and they expect to have higher headcount in one year than they do today. Confidence levels in the economy are slightly lower than in our prior survey, but still elevated. Overall, we view the results of this survey as slightly positive for the railroads. The 2.6% price increase expectation leaves some breathing room from the all-important 2% rate. 2% is important because rail-cost inflation typically hovers in that area, and pricing will need to remain above that level in order for the railroads to improve their operating ratios. Shippers’ business trends are improving. Intermodal pricing competitiveness seems to have not let up yet, according to a recent call we held with private trucking and 3PL executives and the data we collected in this survey. North American rail volumes rose 4% in 1Q17 on an easy comparison of -7% in 1Q16. We continue to prefer Norfolk Southern and Genesee & Wyoming as our top rail picks.”

First-Quarter Rail Equipment Survey

The percentage of shippers who will or may order railcars decreased slightly, “but the conviction level about ordering increased significantly,” says Jason Seidl. “On a same-shipper basis, both the percentage of shippers intending to order railcars and their conviction level about ordering increased. We view the results as a net modest positive and continue to favor Greenbrier, Trinity and ARI.”

The results of the survey are “a modest net positive for new railcar demand in the next 12 months,” Seidl notes. “While only 46% of shippers now say they will or may order equipment in the next 12 months—down from 50% in our 4Q16 survey—the conviction level about ordering increased significantly within this 46% who say they will or may place orders. The results on a same-shipper basis represented the fourth consecutive quarterly improvement. Both the percentage of shippers intending to order railcars and their conviction level about ordering increased modestly. The survey results are directionally consistent with our view that the industry fundamentals are beginning to improve somewhat.”

Cowen has held “a relatively positive, largely non-consensus view of the industry for the past year, namely on our Outperform-rated Trinity and Greenbrier, and more recently on ARI, which we upgraded to Outperform from Market Perform on March 20,” Seidl says. “We continue to have favorable, long-term views of these three companies and believe there is more upside than downside to industry fundamentals, but the improvement, as we’ve long maintained, is likely to be slow and gradual.”

Frac sand hoppers fully deployed

The railcar industry’s frac sand hopper fleet appears to be approaching full utilization, if it’s not already there, according to takeaways from Cowen’s recent roundtable conference call with industry experts. “This could pull forward delivery dates on some of the roughly 16,000 frac sand hoppers in the industry backlog, in our opinion, leading to upside to current production forecasts for 2017,” Seidl and Elkott note.

Cowen hosted a roundtable conference call with three railcar industry/rail logistics experts on April 6. “Two of the panelists suggested that most, if not all, of the industry’s frac sand oversupply has been recalled back into service. Additionally, one panelist gave an example of one lessor whose sand car fleet has now been fully deployed. We are maintaining our production forecasts for the builders pending more information from their earnings releases. However, we now believe upside exists to the midpoint of industry production expectations, which range roughly between 37,000 units and just over 40,000 units.

“Due to prolonged frac sand car demand weakness starting with the late 2014 energy bust and lasting for much of the past two years, we believe a material portion of the current industry backlog of roughly 16,000 units may be for delivery dates beyond 2017 as many customers negotiated ways out of receiving such cars sooner. Now that a strong frac sand recovery is in full force, and the oversupply of cars appears largely gone, we would not be surprised to see some delivery dates pulled forward again. Additionally, with some lessors’ sand equipment fully deployed, they must contemplate additions to their fleets. GATX, for instance, had fewer than 3,000 frac sand hoppers in its fleet at the end of 2016. Cement is another commodity that could help drive demand for this equipment, especially as an infrastructure bill may now be introduced earlier than many may have originally anticipated.”

“The notable rise in inquiries for new equipment, which started late last year, appears to have continued,” say Seidl and Elkott. “However, it has not yet translated into higher orders. One of our panelists appeared optimistic that this could occur in second-half 2017. Meanwhile, first-half 2017 orders, the panelist suggested, are unlikely to dip materially below the level we saw in 4Q16, which was just under 5,000 units.”















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