WAB, Rails: Deteriorating Environment

Takeaway: By the time utilization declines amid peak equipment deliveries and weak traffic, it may be too late to exit/short WAB, if we are correct.

Overview

In our WAB black book, we suggest that US freight rail volumes should weaken and lead to rail capital spending declines into 2016.  A decline in US freight rail capital spending (orders, not sales) would be a serious negative for WAB, as WAB shares are priced for continued secular earnings growth.  Recent data suggests that this thesis is, perhaps, playing out.  In the last few weeks, the shares US railroads have underperformed as rail data has softened.  We expect weaker volumes to negatively impact the shares of equipment suppliers over time. 

G&W, KSU Guidance Cuts

“G&W’s traffic in the first quarter of 2015 has been weaker than the Company’s expectations due to severe winter weather in four of G&W’s North American regions, as well as weakness in certain commodity groups, including steam coal and metals. Based on first quarter results to date, G&W expects total revenues in the first quarter to be approximately $375 million, or $25 million below its guidance of $400 million provided on February 10, 2015. In addition, G&W expects costs to be approximately $5 million higher as a result of the extreme winter conditions. As a result of these factors, G&W expects net income in the first quarter of 2015 to be approximately $10 million below guidance.” 

- GWR Press Release

While Crude by Rail has received some attention, the G&W guidance cut also notes weakness in steam coal and metals.  With the approach of the Mercury Air Toxics implementation, coal volumes seem likely to weaken further.  Industrial metals prices are also not encouraging.  KSU also lowered its outlook on March 23rd, and specifically mentioned lower expenses as an offset to a weaker environment.

Intermodal

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Here is what Cass has to say on mode shifting back to trucks:

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Coal

After a few surges in output, coal production is down again.  SCOTUS is unlikely to rule on MATS regulations until well after its mid-April implementation.

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Crude By Rail

Lower crude oil prices have not had a positive impact on the growth in crude by rail shipments. 

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Hard To See Growth in 2015

While some categories, like Chemicals, continue to expand, it is challenging for us to see rail growth in the current environment.  By the time utilization has declined amid peak equipment deliveries and stagnant traffic, it will be too late to exit/short WAB, assuming we are correct.

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