For the week ending November 10, 2012, The Association of American Railroads (AAR) reported an overall decline of 5.4% in the carloads on a Y-o-Y basis. However, the intermodal volumes increased by 1.9 percent.
Out of a total of 20 commodity groups, 12 groups displayed growth on a Y-o-Y basis. Top gainers included petroleum products (45.5 %), farm products (excluding grain) (24%) and automotives and equipment (13.6%). On the other hand, the carloads for metallic ores gave the worst performance with 20.9% decline Y-o-Y, followed by coal (-15.5%) and grain (-9.8%).
The grains' carloads have been adversely affected by the drought in the U.S. However, according to U.S. National Climate and Data Center, the situation is expected to improve in the future. The drought, in some parts of the U.S., finally came to an end this October after 16 consecutive months of warm weather. The remnants of Sandy Hurricane brought wet conditions to the Northeast region at the end of October. The wet weather also improved the drought conditions in the Midwest region. However, the harvest season is gone and therefore, the agricultural products are unlikely to see a rebound until the next fall's harvest.
Coal accounts for the largest portion of the overall carload freight, by far. Currently, coal accounts for around 40% of the total carload freight. Therefore, coal has an important role to play in the industry's performance. Obama's re-election has sent bearish signals to the market regarding the future of coal. In the past, Obama's administration has passed laws that have restricted coal's consumption in the U.S. Last year's MACT rule is one example-- it requires emissions controls for hazardous materials emitted by coal plants.
However, on a positive note, the gas prices are going up in the winter season, which has slowed down the pace of coal-to-gas switching at the U.S. power plants. According to Barclays, the cost advantage of natural gas over coal is lost if the retail price for gas crosses the mid $3-4 range (this has been discussed in detail under the UNP section).
Shale gas boom has been both a boon and a bane for the railroad industry. On one hand, it has provided the market with cheap and abundant supply of natural gas and therefore severely affected the demand for coal. On the other hand, it has provided railroads with incremental carloads in the form of transportation of crushed stone, sand and gravel to the shale gas sites. On a year-to-date basis, the shipments for frac sand have increased by 8%.
The shipments of petroleum products have been on a rise this year especially, after TransCanada's $7 billion pipeline proposal was denied in January. There has been an overall 44% rise in the petroleum shipments on a YTD basis.
The automotive shipments have witnessed a rise as well, as the U.S. auto industry is gradually recovering from the 2009 recession. The following chart shows the SAAR levels in the U.S. for the previous 12 months.
October's numbers were spoiled by Sandy Hurricane. However, the demand that could not be fulfilled at the end of October is expected to be met in November and December. Therefore, both months are expected to display strong automotive results. This means more carloads for the railroad sector in the next two months.
The following shows the exposure of different railroad stocks to different commodity groups:
(click to enlarge)
CSX and NSC
The chart shows that CSX Corp (CSX) and Norfolk Southern Corp (NSC) have almost similar exposures to different groups of commodities. A big chunk of their revenues come from the transportation of coal. The coal carloads, as already mentioned, have been a nightmare for the railroad companies.
Even coal exports present a bleak outlook in the near-term future. Both CSX and NSC were bearish about the coal exports in their conference calls. The export levels rose in the month of July and August (5% in both the months on a Y-o-Y basis) due to high coal demand from Europe as Europe has decided to cut most of its nuclear power outside France. However, after displaying strong results for two consecutive months, the coal exports took a U-turn and declined by 28% Y-o-Y in September. The management believes that the decline will continue in October due to soft demand from Europe and Asia. Due to weak demand, the export coal prices have tumbled as well. The API 2 Futures, an indicator of the coal prices imported into Northwest Europe, are trading at around $90 mark-- well below their peak levels.
In the near term, both companies are also expected to suffer from weak demand for frac sand and drilling-related material in the Marcellus shale region.
Kansas City Southern (KSU) is expecting incremental sales from the automotive segment. There are a total of 10 automotive assembly plants in Mexico and nine of them are controlled by KSU and Ferromex. New plants are also expected to open in the next 2-3 years, which will give additional carloads to the railroad company. In its conference call, the company claimed that $68 million worth of business is expected to come from the automotive segment through 2015.
The company does not have exposure to metallurgical coal, which means that a current weakness in the export market will not cause any harm to its revenues. However, the biggest risk that the company faces is that more than 50% of its revenues come from Mexico and therefore any hit to the Mexican economy will give a huge blow to KSU's sales.
Union Pacific Co (UNP) is better positioned than most other rails from a commodity exposure perspective. Most of the coal transported by UNP comes from Power River Basin (PRB). In 2011, 75% of UNP's total coal carloads came from this region. The PRB coal is competitive versus the natural gas price at around $3/btu. By this I mean that natural gas will not be a cheaper substitute for the PRB coal if its price crosses the $3/btu mark. The PRB coal is of low quality as compared to coal obtained from Illinois Basin or Appalachian coal. The coal of Illinois Basin becomes competitive versus the natural gas price in the range of $3.5-$4. Similarly, the Appalachian coal becomes competitive versus the natural gas price at $5. At the current natural gas spot price of $3.66, UNP will definitely recover some of its car loads that were lost after the shale gas boom.
UNP is also witnessing a sharp rise in the crude oil shipments as it transports crude from Bakken to Saint James Louisiana. On a negative side, 17% of UNP's revenues come from agricultural products which can be dangerous given that the drought is expected to hurt the agriculture-related carloads.
The railroad stocks have been severely hit by the shale gas boom as coal accounts for a large chunk of their carloads. A decline in the export coal volumes have added to the woes of the railroad industry. However, lately, a rise in the natural gas prices and strengthening U.S. auto industry has helped the stocks to recover some of their lost revenues.