The US railroad industry has been facing a hard time over the last few years due to several reasons, the major one being the global inclination towards the use of clean sources of energy, which has slowed down the coal shipments in the US drastically in the last 5 years. Further, the weakness in the US economy in the several years following the 2008 meltdown has decelerated the pace of growth of the railroad companies. However, 2017 has been a turnaround year for these companies so far, and the industry is suddenly attracting a number of active investors. Here are some of the factors that we believe will drive the value of railroad companies in the next few quarters.
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Improvement In Coal Shipments
As the world is moving towards cleaner and environment-friendly sources of energy, such as natural gas etc., the use of coal has gone down significantly in the last five years. Just to put things in perspective, the US coal production has gone down by 8% compounded annually between 2011-2016, while the US coal consumption has reduced by 6% compounded annually during the same period). Consequently, the coal shipments carried out by the US railroad companies have suffered drastically, declining from over 800 million tons in 2011 to less than 500 million tons in 2016. Since coal shipments contribute a sizeable portion of the top-line of these railroad companies, their performance has been deteriorating over the last few years.
Source: Annual US Railroad Traffic, Association of American Railroads (AAR)
However, the new President Donald Trump has emerged as a ray of hope for several dying industries, particularly the railroad sector. The President is creating a favorable regulatory environment under his administration, which is expected to revive the coal industry. In fact, the US railroad companies have seen a sudden jump in the coal shipments since the beginning of 2017. The US coal shipments currently stand at 3.83 million carloads year-to-date, 9.5% higher compared to the same period of last year. This has led to a sharp improvement in the revenue as well as bottom line of railroad companies such as CSX Corporation ( CSX ), Norfolk Southern Corp. ( NSC ) and Union Pacific Corporation ( UNP ). We expect this trend to continue in the coming quarters, which is likely to further drive the value of these companies.
Strengthening of the US Economy
The economic activity in the US had witnessed a steep drop since the recession of 2009-2010, which caused a slump in most of the industries, including the railroad sector. However, with the help of quantitative easing and effective monetary and fiscal policies, the country has emerged out of the shackles of the downturn over the last few years. This is evident from the fact that the country's unemployment rate, which had risen up to 10% in 2010, has stabilized at around 4% of late. As a result, the Federal Reserve has raised the interest rates on a sustained basis for the last 3-4 quarters.
Further, the US dollar has continued to strengthen versus a majority of the other currencies, indicating a steady growth in the economy. In fact, the US Gross Domestic Product ( GDP ) rose by 3% in the third quarter despite the disruption caused by the recent hurricanes, beating the market estimate of a 2.5% rise in the GDP. Given the strong recovery in the US economy, there is likely to be an improvement in the construction markets, particularly non-residential construction, which is expected to prop up the rail shipments of industrials as well as non-metallic minerals. Consequently, we expect the short term value of US railroad companies to rise notably in the next few quarters.
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