Tuesday, March 09, 2010

Analysts: Robust rail revenue growth predicted

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Two leading railroad industry analysts have weighed in with projections on railroad traffic and revenue growth. 

Dahlman Rose & Co. recently held a seminar with freight economist and transportation industry veteran Noel Perry, who offered a wide array of observations, views, and predictions on the railroad and trucking industries.

“On the rail front Perry’s traffic forecast calls for 2010 carloading growth reaching the 6% to 7% range, with growth accelerating in 2011,” said Director-Equity Research and Railway Age Contributing Editor Jason Seidl. “While a vigorous return of traffic, along with solid pricing, should lead to strong revenue growth over the next few years, top line improvement will not necessarily be accompanied by equally robust operating profits, according to Perry.

Contrary to the view that the railroads and many in the investor community have expressed regarding high incremental margins emerging in the industry in tandem with the economic recovery, Perry suggests that the railroads’ ability to keep costs down will diminish significantly as the ongoing upturn in the market shifts into high gear. While he believes that the companies are likely to grow their top lines at impressive rates in the next couple of years, he cautions that a deterioration of service metrics is likely to accompany growth in carloadings. He notes that, indeed, velocity has declined in recent weeks as volumes have started to return (though weather may have had an impact as well). The deterioration of service levels, according to Perry, is a reflection of the traffic congestion, which should ultimately translate into higher operating expenses. Labor is one example of congestion-related costs that could increase significantly.” 

Morgan Stanley analyst William Green, in a weekly report, said that rail volumes “could grow at double-digit rates in 2010,” with “recent weekly traffic data as thesis-confirming. As a result, we are adjusting estimates slightly higher for many of the railroads we cover, and in all cases, we continue to be significantly above consensus. In the coming months, we expect upside revisions to consensus driven by the following trends: (1) Weekly volumes tracking better than expectations, (2) Operating leverage to recovering volumes, and (3) Sustained momentum on core pricing. CSX and Union Pacific (a Morgan Stanley Best Idea) are positioned most favorably with respect to these themes.”

Greene also gave Canadian Pacific and Kansas City Southern high marks: “CP enjoys a number of favorable company characteristics that we look for in a recovery scenario, notably (1) exposure to higher-growth markets (i.e. outsized export bulk commodity exposure) and (2) easy operating margin comps to support earnings growth. . . . [D]espite balanced risks relative to other railroads, we see absolute upside through year-end.” As for KCS: “Not only does KCS benefit from all of the cyclical and secular trends driving Class I’s, but the company also benefits from a number of unique positives, including the recent re-pricing of a major contract driving industry-leading pricing growth in 2010, and unique volume growth opportunities (such as cross-border intermodal).”