Barclays Cuts Part Of Transportation Sector: Downgrades Kansas City Southern, Norfolk Southern, Canadian National

In a report published Thursday, Barclays analyst Brandon R. Oglenski downgraded the rating on the North America Airfreight and Ground Transportation sector from Positive to Neutral, after having been bullish on transports the past year.

“Incrementally softer industrial demand, challenging commodity markets, high relative inventories and significant USD appreciation suggest North American industrial activity could be in the penalty box well beyond this summer,” analyst Brandon Oglenski said.

In the report Barclays noted the key issues for this sector:

• Incremental deceleration in industrial demand, with high level of inventories and uninspiring global data
• Strengthening of the US dollar could result in a “prolonged downturn” in North American industrial output
• Despite recent declines, transportation valuations are still not “cheap enough”

Oglenski downgraded the rating on Canadian National Railway (USA) CNI from Overweight to Equal-Weight, while reducing the price target from $67 to $61.

“CN’s financial return profile is sector leading, driven by a proven management team with a solid strategy focused on supply chain collaboration. However, CN, along with peer CP, maintains roughly 10% revenue exposure to direct energy markets such as crude oil, frac sand and drilling pipe,” the report said.

Barclays downgraded the rating on Kansas City Southern KSU from Equal-Weight to Underweight, while reducing the price target from $112 to $93.

Oglenski said that the reasons for the downgrade were:

1. Lowered earnings outlook - EPS growth estimates for 2015 and 2016 have been reduced by 20 percent and 22 percent, respectively, from the estimates at the beginning of the year.
2. Relatively high valuation – The relative valuation of Kansas City Southern’s shares on 2016 estimates “is still four turns higher” than its close peer Union Pacific Corporation UNP (rated Overweight, PT reduced from $121 to $112.
3. Limited financial returns compared to the sector – “KSU has outspent its peers in capital expenditures, leading to similar growth but lower returns.”

Oglenski downgraded the rating on Norfolk Southern Corp. NSC from Overweight to Equal-Weight, while reducing the price target from $96 to $91.

The report mentioned that that downgrade was based on:

1. Softening eastern coal volumes to continue to be “a significant earnings headwind”
2. Low fuel prices indicate “limited ability to recoup lost surcharge profits”
3. Service recovery could require additional costs, restricting upside even if volume growth improved