Three recently released Cowen and Company reports—Fourth-Quarter 2019 Rail Equipment Survey and Rail Shipper Survey, and Rail Estimates—indicates that, though times are tough and rail freight traffic in most sectors has not begun to recover, “the sky isn’t falling.” Here’s what Cowen Managing Director and Railway Age Wall Street Contributing Editor Jason H. Seidl, along with analysts Matt Elkott and Adam Kramer, see it.
4Q19 RAIL EQUIPMENT SURVEY
“Railcar demand appears to be holding at or just below the tempered levels we saw the past quarter on steeper rail traffic declines and ongoing PSR implementation. This and broader market jitters could continue to weigh on Trinity and Greenbrier in the near term, although TRN’s eventual CEO announcement could move the shares. Wabtec remains our top pick.
“When it comes to order activity, we consider four key metrics: (1) The percentage of ‘all participating shippers’ who will or may order railcars. (2) The conviction level about ordering (the split between ‘yes’ and ‘maybe’) within this ‘all participating shippers’ group. (3) The percentage of ‘same shippers’ who will or may order railcars. (4) The conviction level about ordering (the split between ‘yes’ and ‘maybe’) within this ‘same shippers’ group.
“The first and second metrics deteriorated slightly in 4Q19, the third improved somewhat, while the fourth metric remained unchanged. Responses to the question about order sizes were mixed. Among the shippers who said they don’t plan to order railcars in the next 12 months, the percentage who said it is because they don’t have incremental equipment needs increased, another slight negative.
“Roughly 51% of all shippers surveyed said they will or may order railcars in the next 12 months. This compares to 53% in our 3Q19 survey. About 49% now say they do not plan to order railcars, compared to 48% in our prior quarter survey. Within the 51% of total shippers who are contemplating orders in the next 12 months, 57% said ‘yes,’ they plan to place orders (61% in 3Q19), while 43% said ‘maybe’ (39% in 3Q19). This points to a decreased level of certainty about ordering within the total shipper group relative to the past quarter.
“On a same-shipper basis, about 51% of same shippers in 4Q19 said they will or may order railcars, compared to 47% in 3Q19. Roughly 49% do not plan to order railcars, compared to roughly 53% in 3Q19. Within the 51% of same shippers who are contemplating orders in the next 12 months, 59% said ‘yes,’ they plan to place orders (in line with 3Q19), while 41% said ‘maybe’ (also in line with 3Q19).”
4Q19 RAIL SHIPPER SURVEY
“Shippers are again anticipating price increases of 3.0%, below the survey’s long-term average, but a welcome positive for a rail group that is still dealing with a challenging near-term demand environment and the worst volume declines since 2009. Economic confidence increased, fears of a recession fell and supply chains shifted due to trade concerns. We continue to favor Kansas City Southern the group and top pick.
“Shipper anticipation of rail prices increasing by 3.0% over the next 6-12 months is the same result as our two prior surveys and below our survey’s long-term ten-year average of 3.7%, but still above long-term rail cost inflation. On a same-shipper basis, shippers anticipate a very slight price increase. With rail volumes decreasing by 4% and 7.5% in 2019 and 4Q19 respectively, the 3.0% figure and slight increase among same shippers indicates that the rails haven’t chased volumes by lowering price.
“Many economic and business expectation results from the survey were decidedly positive. 54% of shippers are more confident in the direction of the economy today than they were three months ago, up from just 35% the past survey. Confidence levels in this survey surpassed our survey’s 48% long-term average. This is likely due to trade concerns finally easing. Further, only 23% of respondents believe that there will be a recession in the next 6 months, well below last survey’s 31% response. Shippers expect their businesses to expand at an average rate of 2.4% over the next 12 months, up 30bps sequentially.
“That being said, slightly fewer shippers expect their employee counts to increase over the next 12 months, and fewer noted that business levels over the past few months were positive, compared to the prior quarter.
“The average ‘positive’ rating of rail service (including KCS, KCS de México and Ferromex) increased sequentially to 60% from 53% in 3Q19. Other than Norfolk Southern, all the railroads received better ratings relative to 3Q19, with KCS seeing the largest sequential improvement in service and the highest ‘positive’ rating in the quarter. The average ‘positive’ rating among the railroads (except KCS and Ferromex) decreased 1% y/y however, a surprise given the lower volumes (and PSR gains) in 2019.”
FINE-TUNING RAIL ESTIMATES
“Prior to 4Q19 rail earnings, we are fine-tuning our models, lowering 4Q19 and 2020 carload expectations and conducting other model adjustments. As we flip the calendar to 2020, we are adjusting our valuation to our 2021 EPS estimates, and continuing to favor the PSR railroads, specifically KCS.
“The tale of the tape in 4Q19 has been volumes that declined y/y by 7.5%, the declines accelerating from more mild weakness earlier in the year. Carloads in 1Q19, 2Q19, and 3Q19 declined 1.4%, 4.8%, and 4.4%, respectively, with a full-year y/y decline of 4.0%. Indeed, railroads have been fighting recession-like volume conditions since early 2019.
“We have maintained that Precision Scheduled Railroading-related improvements at KCS, NS and Union Pacific would be successful in cutting costs and driving earnings growth, even amid volume declines and a softening macro. Thus far, this premise has largely been validated in both earnings and share prices.
“Indeed, we have also acknowledged that some stocks in our coverage (including rail stocks such as CN and UP) appear to have gotten ahead of themselves in recent months. In addition, longer-term concerns—intermodal growth, decline in export coal, and the state of the overall economy, among them—are increasingly in play. CSX in particular highlighted the decline and negative outlook for export coal on their 3Q19 conference call.
“With 4Q volumes for the Class I railroads falling short of our expectations, we are lowering volume expectations, adjusting yields based on recent channel checks, and conducting other model adjustments. We lower our 4Q19 EPS estimates for CP, CSX, and UP, maintain our estimates for NS and KCS, and raise CN’s (we note that we lowered CN’s numbers following their guidance revision).
“Second, we lower all of our 2020 EPS estimates other than KCS, which we raise slightly, given our belief that the sole U.S.-Mexico railroad will be able to gain business from supply chain shifts to South and Central Mexico. In addition, we are establishing initial 2021 EPS estimates for the Class I’s and shifting our valuation to these new 2021 EPS estimates, while maintaining our current multiple. We believe that maintaining our current multiple, rather than lowering it, is warranted, given the railroads’ performances over the past few years, executing amid strong volumes in 2018 and now weak volumes in 2019, and with PSR successfully implemented across all the public Class I’s.”