Notes from MARS: Cowen

The Mason Intermodal Container Transfer Facility at the Georgia Ports Authority’s Garden City Terminal. Photo: Georgia Ports Authority/Stephen B. Morton

Crude by rail is set for growth over the next 18 months, while frac sand could begin to moderate in 2H18 as the shift to Permian sands intensifies, according to a report from the Midwest Association of Rail Shippers (MARS) conference prepared by Cowen and Co. Managing Director and Railway Age Wall Street Contributing Editor Jason Seidl. “Ongoing market strength continued to be the main thread across the presentations, tempered only by trade policy concerns. We believe that the railroads will show notable earnings improvement this year.”

“The state of freight remains strong across modes, with some attendees at the MARS conference unable to recall a time quite like this,” said Seidl. “The commentary is consistent with what we have seen in rail volumes. Total North American Class I traffic is up 6.2% QTD y/y as of July 14. This is an acceleration from the second quarter’s roughly 4% y/y increase, which was in turn double the 2% growth registered in 1Q18. Our conference channel checks are also directionally consistent with the takeaways from our July 13 2Q18 Rail Shipper Survey and our July 10 private trucking conference call.

“If there was any other less-than-stellar takeaway beside trade policy concerns it was related frac sand. One energy expert believes frac shipments on rail may have reached peak in 2Q18 as the shift from Northern White to Permian Brown should accelerate. He identified 11 Permian mines already in production and 7 others that have been announced but not yet in production. He projects local sand could become the majority of the Permian supply by late this year, with further share growth in 2019 and 2020. The need for northern sands, however, is unlikely to go away any time in the foreseeable future, albeit at declining rates. We are not too concerned about this phenomenon given strength in many traffic categories and expected growth in others, including crude by rail.”

The same speaker said that U.S. crude production is at record levels with 35% fewer rigs than the 2014 peak. “With no major pipeline projects possible until late 2019 (barring any delays), rail should play a bigger role in the movement of the commodity over the next 18 months,” Seidl noted. “That said, the potential could be limited by network congestion and the existing infrastructure. The railroads, already enjoying the ability to be freight-selective in this robust environment, are likely to think hard before making significant investments in their CBR franchises if a big part of the demand is viewed as a stopgap measure until more pipeline capacity comes on line.”

CN remains Cowen’s top pick. “The company is attacking its network service disruptions through a combination of track and yard expansion, new power, additional cars and more people,” Seidl said.” It remains well-positioned to benefit from improving operations, a strong pricing environment and a solid demand backdrop. This combination has normally led to happy shareholders in the past and we believe will do so again. We expect CN to introduce a new operating plan this fall.”