Friday, August 07, 2009

Analysts: Rail freight traffic hints at a near-term recovery

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While rail freight carloads for 2009’s Week 30 as reported by the Association of American Railroads did not bring about significant changes in weekly year-over-year volume decline rates, there are solid indications that a gradual recovery is under way, say two leading Wall Street firms.

jason-seidl-web.jpg“While there were noteworthy changes in some commodity groups in both directions, the overall picture seems to support the argument for stabilizing volume declines,” says Dahlman Rose & Co. analyst and Railway Age Contributing Editor Jason Seidl (pictured).

“Improving rail traffic is an early sign of industrial recovery,” note Morgan Stanley & Co. analysts William Greene and Adam Longson. “After months of speculation about an economic recovery, July's clear uptick in the year-over-year rate of change in volume has finally lain the foundation for significant second-derivative improvement in the third quarter across most traffic segments. Specifically, economically sensitive commodities showed strong sequential improvement, led by chemicals, metallic ores, and metals—all key inputs in the auto manufacturing process. Grain volumes have also recovered in recent weeks.” However, “while recent traffic trends show small, but meaningful improvement, the real surge in traffic from auto production isn’t likely to materialize until later in August.”

This confirmation of volume recovery “should drive more upside in railroad stocks,” Greene and Longson say. “[Class I] management’s upbeat volume commentary helped lift rail shares during second-quarter 2009 earnings. We expect confirmation of an auto-led rebound to have an incremental, positive impact on investor sentiment and earnings. A recovery in auto volumes themselves will not be a significant driver of EPS revisions given lower margins in the segment. However, the broader impact of increased auto production could be more meaningful for earnings as inputs into auto manufacturing (steel, chemicals, etc.) are high-margin moves for railroads.”

The current long-term outlook: “Railroad earnings have troughed, and 2010 consensus is now too low,” say Greene and Longson. “The markets are underestimating railroad mid-cycle margins and operating leverage to a rebound in volumes, considering recent productivity improvements and proof of pricing discipline.”

The Standard & Poors 1500 Road & Rail Index jumped 3.4% following better-than-expected U.S. jobs data, making it the best-performing S&P index Friday morning.  

“Transports are often considered a good way to play the ‘economy in recovery’ theme,” said Charles Brady of Fox Business News.  More economic activity means more things need to be shipped—everything from raw materials and commodities to producers, to finished goods and products to consumers."

In early afternoon trading on Friday, with the Dow Jones average up 1.43%, railroads were setting a far faster pace: CSX, up 7.28%; Norfolk Southern, up 6.49%; Union Pacific, up 4.71%; Kansas City Southern, up 4.54%; BNSF, up 3.62%; and CN, up 2.78%. CP was up 1.57%.


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