Investors still seem fully invested in the idea of ongoing economic recovery, but maybe that is starting to fade a bit. Not only have investors had to digest disappointing news on job growth, but rail traffic and other economic numbers are starting to look a little wobbly. The question for rail investors, then, is whether there's enough momentum left to replace the ongoing weak demand for coal.
March Numbers Look Familiar
"Ex-coal" has become an important qualifier when looking at recent railroad traffic data, and March was no exception. U.S. rail traffic dropped almost 6% on a year-over-year basis, and over 3% month-over-month for March. Ex-coal, the comparison improves to 2.4% (year over year) and ex-coal and ex-grain, it jumps further to 4.4%. While that's all well and good for the economy, the fact remains that lower carload volume is a headwind for rail operators.
Other numbers were incrementally more encouraging. Intermodal traffic rose more than 3% in March, while both Canadian rail and intermodal traffic rose more than 2%.
The Coal Story Stays the Same
There's still no joy in the coal story. Coal traffic fell almost 16% in March, as utilities continue to cut their coal orders. Not only are utilities benefiting from cheaper natural gas, but warmer winter weather has left utility coal inventories much higher.
This isn't just about Peabody (NYSE:BTU) or Alpha Natural (NYSE:ANR), though American thermal coal companies are certainly suffering from the weak coal market. Coal makes up more than 20% of rail traffic for Union Pacific (NYSE:UNP) (22%), CSX (NYSE:CSX) (24%) and Norfolk Southern (NYSE:NSC) (23%), and generally a larger proportion of revenue as well. Curiously, even though the coal traffic numbers continue to come in lower than generally expected, the stocks have yet to really reflect this.
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Is Industrial Getting a Little Soft?
Unfortunately, there's just not enough strength in other areas of the economy to compensate for these declines in coal volume. Overall industrial product carload volume growth was over 4% in March, but that was a relatively softer number. What's more, the number of categories showing volume growth dropped from 15 last year and 14 in February to 12 in March.
The strong growth in cars is encouraging, but the growth in petroleum shipments from the Bakken is likely to be a relatively short-term phenomenon (until pipelines are built). What's more, a lot of categories like chemicals are running into increasingly difficult comps.
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The Bottom Line
Should investors in railroad stocks run for the hills? There aren't a lot of great valuation bargains right now and analysts are finally starting to trim their numbers a bit. What's more, it's worth asking whether or not the economy is heading for another slow patch as happened in the late spring/early summer of the last couple of years.
All in all, rails are still good bets on the long-term performance of the North American economy, but investors who want to play the long-term story have to be prepared to ride out what could be a multi-month period of turbulence and lowered expectations.
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