Cowen Pre-3Q20: ‘Fine-Tuning Rail Estimates’

Class I third-quarter earnings are coming up, and Cowen and Company analysts Jason Seidl (Managing Director and Railway Age Wall Street Contributing Editor), Matt Elkott and Adam Kramer are fine-tuning their models “to reflect carloads in the quarter, mix, fuel, and other adjustments.” 3Q20 “saw a divergence between carload and intermodal traffic, with the latter driven by pent-up demand and tightness in the trucking market.”

“Expectations for rail volumes entering 3Q20 were for a recovery from the nearly 20% volume decline for the North American Class I’s in 2Q20,” the analysts said. “The story in the quarter has been the divergence in the magnitude of this recovery between bulk carloads and intermodal, with the former finishing the quarter down roughly 13.5% and the latter increasing by nearly 2% y/y. Both Containers and Trailers benefited from the tightness in the trucking market, where TL (truckload) spot rates have spiked to peak-2018 levels, if not even surpassing them per some indices, while containers are also seeing the positive impacts of recovering imports.”

What the Cowen analysts call “the slimmer Class I’s” are “trying to keep the weight off.” 2Q20 volumes fell sharply, but that gave the Class I’s “an opportunity to flex their PSR muscles and show the fruits of their cost-cutting labor. Impressively, Canadian Pacific still managed to post a 57% operating ratio (OR), with CN, Union Pacific and CSX all managing sub-65%,” and Kansas City Southern following closely, at 65.2%. Norfolk Southern was the exception, posting a 70.7% OR, that while worse than the group, was still better than the 72.6% NS posted in 2015, “the most recent challenging freight environment [prior to 2020], and the 70.7% came amid a pandemic. These results, even inclusive of NS, highlight the reduced cost basis that is now table stakes for the Class I’s. Further, NS already showed in its pre-announcement that its PSR efforts are paying off, with 3Q20 adjusted OR expected to be 62.5%. With overall volumes recovering somewhat to finish the quarter down roughly 6% y/y (though we note that 2019 presented easy 2H volumes comps, and volumes are still lagging 2018 levels), the true test will be if the railroads are able to keep expenses down in future quarters, and to what extent.”

Now that 3Q20 is past, Seidl, Elkott and Kramer are updating their carload estimates to reflect Class I performance: “All of the Class I’s, with the exception of CP, beat our carload expectations for the quarter, with CP only missing slightly. NS and UP were the most significant outperformers, at ~4% and ~3% ahead of our expectations, respectively, with CSX, KCS, and CN beating by smaller amounts. In addition to volume adjustments, we also adjusted for mix, fuel, currency, pricing, and other fine-tunings. On an EPS basis, we adjusted our estimates higher for 3Q20 for each of the Class I’s, though only slightly so for CN and CP. With significant uncertainties in the economy, we have chosen to only slightly adjust our 2021 estimates, hoping for more clarity when the Class I’s report 3Q20 figures.”