BB&T: Class I railroads a ‘good news, bad news story’ for investors

The investment bank’s transportation services research team projects higher earnings per share for several of the North American Class I railways, but stock prices have gone up to reflect a less dour industry outlook.    North American Class I freight railways are a “good news, bad news story” for investors, according to the transportation research group at BB&T Capital Markets.
   Railways have taken a beating in the last year as a slump in commodity prices has sent volumes of coal, oil and other energy related cargoes plummeting. But BB&T recently revised upward its earnings per share (EPS) projections, as well as stock price targets, for several of the major railroads in the United States and Canada.
   The transportation research group said there has been a “positive tenor” in its recent discussions with the Class I railways despite short term volumes being impacted by heavy flooding, particularly in western regions.
   “Clearly, coal is a mess and so are other energy-related commodities,” the investment firm wrote in an advisory note. “That’s no surprise.”
  “However, a number of other commodities (particularly housing and construction-related ones) are hanging in there. So is the core chemicals business (excluding crude) and autos. Whether these positive factors persist remains to be seen, but we think consensus EPS estimates are, at worst, in the ballpark, and at best, too low. Considering the flooding, we think that’s pretty positive.”
   The firm raised its first quarter 2016 EPS estimates for Canadian Pacific Railway (CP), Norfolk Southern Corp. (NS) and Canadian National Railway (CN), but lowered them slightly for Union Pacific Railroad (UP) and Kansas City Southern Railway Co. (KCS).
   BB&T said it expects CP to report record EPS of $2.48 Canadian (U.S. $1.88) per share in the first quarter of 2016 thanks to relatively mild winter weather and a one-time land sale of C$55 million. The firm previously projected EPS of C$2.35 per share for CP in the first quarter.
   At NS, BB&T previously projected volumes to drop 7 percent during the quarter, but actual throughput is only down around 3 percent. As such, the investment group has raised its Q1 EPS estimate from $0.90 per share to $0.95 per share.
   The firm also raised its EPS estimate for CN from C$0.90 to C$0.91, “reflecting slightly better-than-expected mix.”
   For UP and KCS, however, BB&T decreased its Q1 EPS estimate from $1.02 per share to $1.01 per share and $1.12 per share to $1.10 per share, respectively. The firm attributed the diminished projections primarily to the abovementioned flooding in the western half of North America, which has caused volumes to come in slightly lower than previously expected.
   Looking ahead to the rest of 2016 and beyond, BB&T is projecting solid revenue and earnings growth for all six of the publicly traded Class I railroads.
   BB&T expects revenues at CN to grow 1.6 percent to C$12.81 billion in 2016, and an additional 6.4 percent and 6.5 percent, respectively, in each of the following years. As a result, EPS is expected to increase from C$4.45 per share in 2015 to C$4.65 per share in 2016, C$5.10 per share in 2017, and C$5.60 per share in 2018.
   CP is projected to boost revenues 1 percent to C$6.78 billion in 2016, followed by a 6.3 percent increase in 2017 and 7.5 percent increase in 2018. BB&T expects EPS at CP to jump from C$8.40 for the full year in 2015 to C$11.20 per share in 2016, C$12.80 per share in 2017, and C$14.70 per share in 2018.
   The firm estimates 2016 revenues will drop 5.7 percent to $11.13 billion at number one U.S. East Coast railway CSX Corp. before rebounding to grow 4.8 percent and 5.3 percent year-over-year in 2017 and 2018. As such, EPS is projected to similarly dip to $1.80 per share in 2016 compared with $2.00 per share last year, but bounce back to $2.00 for the full year in 2017 and grow to $2.20 per share by 2018.
   KCS is expected to follow a similar trajectory, with revenues falling 1.6 percent to $2.38 billion for the year and rising 7.2 percent and 7.9 percent, respectively, the next two years. BB&T projects KCS’s EPS to drop just $0.02 per share to $4.48 for 2016 before increasing to $5.00 per share in 2017 and then $5.50 per share in 2018.
   NS, which is still in the midst of fending off a very public takeover attempt by CP, is also projected to post a 3.2 percent decline in yearly revenues in 2016 to $10.17 billion, but BB&T estimates revenues will grow 4.6 percent and 5.2 percent, respectively, in 2017 and 2018. EPS, on the other hand, is expected to grow steadily, from $5.10 per share in 2015 to $5.35 per share in 2016, $5.95 in 2017, and $6.55 in 2018.
   Revenues at UP are expected to slip 4.1 percent year-over-year to $20.93 billion before growing 5.1 percent in 2017 and 5.9 percent in 2018. BB&T projects full-year EPS of $5.32 in 2016, down slightly from $5.49 per share the previous year, but full-year EPS of $5.80 per share and $6.35 per share, respectively, the following two years.
   “The good news, at least from our perspective, is that consensus EPS estimates feel like they have bottomed (at least for a while) after many months of negative revisions,” said BB&T. “The bad news is that the stocks have begun to reflect it with Class I rail equities up an average 6% this month versus a 5% gain in the S&P 500.”
   “What’s behind the move higher? We think it’s mostly macro— i.e., commodity prices stabilizing and economic figures not as bad as feared,” the firm added. “Looking forward, comps get materially tougher for the eastern rails in the coming weeks and through most of the summer.”