Rail stocks, specifically CSX Corp. (NYSE:CSX) and Norfolk Southern Corp. (NYSE:NSC) are expected to struggle in the first quarter as investors digest the reality that coal will be weak through the first half and earnings revisions skew downward in coming weeks.
Historically, coal has been the most strategically significant traffic segment for the Class I rails, specifically as one of the largest drivers of freight revenue and volume.
"Coal accounts for 20-30 percent of rail traffic is among the rails' highest-margin traffic segments. With a poor 1H outlook for domestic demand (~80% of Eastern, ~100% of Western volumes) & exports softening off 2011's multi-year peak, coal will be an increasingly strong drag on rail EPS growth in 1H 2012," Susquehanna Financial analyst Matthew Troy wrote in a note to clients.
Additionally, economic headwinds in Europe grew stronger and demand for the met coal/steelmaking is expected to drop.
Meanwhile, the U.S. Class I originated coal volumes fell 4.2 percent in the most recent week, a point below the 4-week and year-to-date trends of down 3.2 percent and 2.7 percent, respectively. On the utility side, stockpile levels continue to remain elevated both in terms of days inventory and absolute tonnage, proof that the mild winter is reversing and doing significant damage to the pace of stockpile normalization.
With CAPP utility and export coal seeing the harshest headwinds, eastern rails CSX and NSC will be hit by coal's tough start to 2012. Confirming the tough times, CSX this week dropped its guidance to a "low double-digit decline" in 2012 utility volumes.
The analyst sees trading risk and downward EPS revision bias for CSX and Norfolk into March due to fears of declines in export coal and warm weather stalling hopes of domestic volume recovery until the third quarter.
"As we don't foresee a positive catalyst to realistically reverse sentiment ahead of the summer burn season, we think this perception will continue to weigh on eastern rail shares near-term," Troy added.