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Railroad managements have now reported their second quarter and cumulative results through the first half of 2019. The press releases were basically focused on the companies’ financials and accounting information. Revenues and yield dominated the measurements, as did resulting cash flows, earnings per share and return on investment.
The conference calls that followed the press releases focused upon analysts questions that sometimes challenged management’s financial assumptions and outlook regarding the business revenues and yields ahead for the second-half of 2019.
Clearly, quarterly reports are geared towards profitability and prospects of buying and selling of stock.
Multiple parties utilize independent revenue and operating expense spreadsheets (models to estimate outlooks about each of the seven major Class I railroads. The analysis is often stated as a series of calculations. The projections are typically stated with a high/low stock price and risks.
If you’re a FreightWaves shipper, that’s not really your interest.
Your perspective isn’t about buy or sell valuations. It’s about how the rail movement workload by key lanes and basic commodity sectors will change.
You are focused instead on the ‘waves’ of freight that will or will not show up as demanded movement… and the railroads’ capabilities to supply that predicted volume.
In short, how will the supply of railroad resources play out against market demand in the remaining five months of 2019?
What’s that business volume outlook look like? The market demand outlook is unclear.
Experts differ in their projections of both railway and trucking traffic. There are mixed economic outlooks in the marketplace regarding freight demand. Even the railroad executives couldn’t agree on their volume forecasts. For example, CSX (NASDAQ: CSX) was slightly negative, while Norfolk Southern (NYSE: NSC) was more positive.
Let’s examine two rail markets – Canada and the U.S.
Why two? Because they differ.
Canada has a distinctive upside for rail freight. That’s driven in part by higher growth rates along the Canadian track network.
Both Vancouver and Prince Rupert ports see strong year-ending growth in imported containers that originate in Asia.
Crude oil by rail out of Alberta (plus the Bakken) is also increasing.
However, remember that the U.S. railroad network moves three to four times the total volume of the Canadian rail network. Population density plays a part in this difference.
Here are a few comparisons to keep in mind about the relative sizes of the two railway markets.
Both Canadian railroads see continuing strong second-half traffic volume. The consensus is that both Canadian Pacific Railway (NYSE: CP) and Canadian National Railway (NYSE: CNI) will see significant traffic growth in intermodal, coal, grain and crude oil into December.
Both grain and intermodal traffic volume on CP and CNI might grow at more than a 3 percent rate during the remaining months. Why so high?
It could be source competition.
Canada railroads may pick up some of the slack seen in U.S. trade. There could be substitution selling of Canadian-sourced grain into international markets resulting from rain and flood disruption of U.S. planting and harvest dates for crops of Midwestern corn, wheat and soybeans.
Back in the United States, rail freight growth has definitely slowed this year.
(Photo credit: BNSF)
Western railroad companies like BNSF (a unit of Berkshire Hathaway – NYSE: BRK.A) and Union Pacific Corporation (NYSE: UNP) have been hammered by rain and flood damage. The physical inability to move freight over strategic rail links has taken a toll on traffic volume growth. Freight cannot be moved when the railway tracks are flooded or worse, washed out.
However, flooding doesn’t explain the drop in eastern railroad volume.
Some of the drop in the East is a result of selected lower volume and lower profitability intermodal lane exit strategies.
A second force is the overcapacity in trucking and the resulting drop in spot rates that are now in certain short to moderate lane distances making trucking cheaper for the shipper than intermodal rail.
It appears that the railroad response to these unexpected spot rates has been to maintain pricing discipline and margin yield. Translation – the railroad companies don’t appear to be lowering price to keep volume.
How long might this pricing and margin strategy continue? It is hard to tell. But given that the tradition of railroad pricing as private contracts – it’s likely that there may not be any railroad company pricing changes until 2020.
There may be some intermodal third-party contract price discounting against the rates they have from the big railroad companies.
Intermodal volume trending
At the beginning of 2019, some experts like Ron Sucik conservatively estimated that total year intermodal growth would be in the 3.5 percent range. That was based upon the results from the first two months. Others expected more robust 5 percent growth in intermodal.
In contrast, the first quarter of 2018 saw a robust 7.2 percent increase. That marked the highest first quarter intermodal growth in nearly four years.
As July 2019 closes here is the current U.S. intermodal scorecard:
Intermodal U.S. units were down 5.7 percent for the second quarter
Intemodal U.S. units were down 7.2 percent during June
The June drop marked five continuous monthly declines
About 3 percent (9,000 cars) of the intermodal fleet are ‘stored’
In perspective, the first half of 2019 is still a stronger intermodal volume than occurred in the same period of 2017.
A five-month volume outlook
Indications of lower import container volumes moving towards key U.S. West Coast ports suggest a possible lowering of transcontinental double-stack train demand into August. If true, this is going to lower year-over-year third quarter intermodal rail volumes.
It is possible that the next five months might see a 3 to 5 percent drop in year-over-year intermodal volume.
That’s not a prediction. It is a precautionary alert based upon signals in the overall economy and circumstances surrounding international trade.
In contrast, going back to the 2010 to 2012 period, the movement of domestic and international containers by rail grew in the 8 to 12 percent range.
Meanwhile, freight-sensitive economic indicators like industrial output remain weak into the summer months. Auto manufacturing and high auto inventory are another possible flashing alert. Also, no big grain export sales have been announced.
The initial U.S. second quarter GDP number of only 2.1 percent is another challenging indicator.
Growth in the goods sector of the U.S. economy was recently estimated at just 1.4 percent. That sector has been declining since the second quarter of 2018. This mark is now back to its fourth quarter 2015 to first quarter 2016 range of 1.4 percent to 1.7 percent.
Beyond rail intermodal, the carload freight sector volume is also likely to drop. A 2 percent year-over-year third quarter and fourth quarter decline in carload units seems realistic.
What’s your volume view?
