After years of steady growth, railway share prices have been in a downward spiral, as the U.S. economy wobbles and shipments of coal and oil plunge.
Union Pacific Corp. and Norfolk Southern Corp. are down by 12 per cent this year. Kansas City Southern is down by 23 per cent. In Canada, share prices of the two major rail carriers have fared better than those of their U.S. rivals. But neither Canadian Pacific Railway Ltd. (down 3 per cent) nor Canadian National Railway Co. (down 6 per cent) are immune to what afflicts the North American rail sector: declining shipments amid weak consumer spending and industrial production.
"A lot of people have said railroads have had their run and right now they might look like they are correct, but in the long run they might wish they hadn't," said Anthony Hatch, a transportation analyst and founder of New York-based ABH Consulting.
Mr. Hatch said the economic headwinds are temporary, and the 2-per-cent year-to-date drop in car loads is mainly because of coal and oil. The millions railways have spent improving their service and operations have given them the power to raise prices. Throw in lower fuel prices and solid intermodal services and railways start to look a lot healthier, he said.
Here are four reasons rail stocks have lost some their shine:
In the simplest terms, railway stocks track the U.S. economy. Factory inputs and outputs, automobiles and other consumer goods all move on the rails. So investors in railway stocks have been nervously eyeing a number of signs that the world's biggest economy is slowing. Real gross domestic product growth of 0.2 per cent in the first quarter missed expectations of 1 per cent. At the same time, the rise in U.S. consumer spending slumped to 1.9 per cent from 4.4 per cent in the fourth quarter, while business spending fell to minus 3.4 per cent. On the positive side, the labour disruptions that snarled shipments in and out of the U.S. West coast are over, and U.S. central banker Janet Yellen said a strengthening economy might prompt a hike in interest rates by the end of the year.
Coal is the biggest source of revenue for railways in the United States, accounting for 40 per cent of tonnage and 20 per cent of revenue, according to the Association of American Railroads. (In Canada, grain is king.) Demand for coal has fallen as power plants have begun generating electricity with natural gas, which has plunged by more than 40 per cent in price over the past 12 months. As a result, the number of coal cars on U.S. rails is down by 6 per cent this year. Demand for thermal coal is not expected to roar back. Stricter emissions regulations and the conversion of some power plants to natural gas have helped reduce CSX Corp.'s coal revenue by $1-billion since 2011. Demand and shipments of higher-priced metallurgical coal, which is combined with iron ore to make steel, have also plunged as the world's steel makers slash production amid a global glut.
Rising production of oil in places there are few pipelines – North Dakota, for one – gave railways a fast-growing new source of revenue. Hauling crude oil quickly began to account for about 8 per cent of sales at CN and CP. But oil producers have slashed output and staff as crude has plunged to $60 (U.S.) from $100. The number of crude carloads moved by the big North American railways is down 14 per cent this over the same period last year, prompting investors, analysts and railways to revise their forecasts.
Mr. Hatch said in an interview crude by rail is beginning to resemble the grain business, with volatile prices and volumes. He said the flexibility of rail, and some attention to fees and costs, could see the business of moving crude settle into a smaller but reliable source of revenue for carriers. "Maybe people are starting to say, 'It was all great, [now] it's all gloom. Maybe the reality is somewhere in between,'" he said.
CP's attempt to merge with Florida's CSX Corp. in the fall gave a boost to the share prices of other railways. Railway mergers are back, the thinking went, and if CP couldn't snag CSX, then it would go for Kansas City Southern or Norfolk Southern. CN, BNSF Railway Co. and Union Pacific would then be forced to look for a partner to compete with the CP-CSX combination, which offered shippers a clear line from the Pacific Ocean and Midwest to the East Coast.
CSX refused to dance, as CP chief Hunter Harrison put it, over fears the U.S. Surface Transportation Board would never allow it to happen despite Mr. Harrison's assertions a union would improve railway service and thus meet the regulator's approval. CP has said its merger dreams are on the shelf, and the industry's shares have lost their takeover froth. That is, except for CSX. An unknown buyer rumoured to be William Ackman's Pershing Square Capital Management more than doubled the company's trading volume for a few days in April, driving up the share price by 15 per cent. Mr. Ackman took a stake in CP in 2012 and installed Mr. Harrison as CEO. Under Mr. Harrison, CP's share price has almost tripled and revenue and profit have set records. CP's chief operating officer Keith Creel has dismissed speculation Mr. Harrison would jump to CSX, saying there is "little to no chance of that occurring."