Friday, January 08, 2010

Morgan Stanley: Improving coal trends to boost rail stocks

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Noting that coal traffic throughout 2009 “has been a significant drag” on freight rail traffic and, consequently, on freight rail company share values, Morgan Stanley analysts William Greene, Adam Longson, and John Godyn, in a report released Friday, say that change is looming.

“In recent weeks, sequential data shows that coal stockpiles have sharply declined,” the trio wrote. “In fact, according to industry consultant Genscape, U.S. generators have recently averaged 63 days of coal supply. While still up Y/Y, this represents a marked improvement from the ~80 days of inventory levels seen as recently as 3Q09, which led a number of rails to reaffirm negative views on domestic coal prospects during their earnings calls. In contrast, should recent trends continue, 4Q09 management commentary on domestic coal trends is likely to be far more upbeat--a point which could excite investors.”

Casting an eye on the harsh winter weather enveloping much of the U.S., Morgan Stanley said, “The silver lining in recent cold weather trends is greater coal demand,” adding, “[I]nvestors are likely to focus on the weather's silver lining--increased heating demand and electricity consumption. In addition to directly reducing existing coal stockpiles, greater heating demand also puts upward pressure on natural gas prices (as we have seen recently). If it continues, this trend is likely to reverse the price-driven substitution effect (more natural gas, less coal) we witnessed in 2009 when natural gas prices crashed.”

Based in part on those developments, Morgan Stanley reiterated its “attractive view on freight—rails in particular.” Greene, Longson, and Godyn concluded, “We like freight stocks as a way to play the economic recovery, particularly stories where we see positive cyclical and secular trends such as the rails.  Easing legislative concerns are likely to refocus investors on key rail investment positives including: (1) operating leverage to recovering volumes, (2) the pricing story, and (3) continued productivity improvements.”