Macquarie Analyst Downgrades Union Pacific, Upgrades Kansas City Southern: What You Should Know

Macquarie Research had noted in an earlier report that there was downside to rail growth expectations in view of the upcoming gas capacity in 2017-2018. Having incorporated the estimated impact, Macquarie's Cleo Zagrean said that the rail forecasts indicated "a convergence of LT EPS growth in the high single digits for all rails except KSU." Zagrean stated that coal volumes were now expected to decline 16 percent in 2015, 5 percent in 2016 and 7 percent in 2017, translating to an overall volume decline of 4.6 percent this year and 1 percent growth in 2016 and again in 2017, "with related negative mix effects on pricing (2%+ pricing in ‘16/'17) and margins (160bps OR gain in '16 and only 80bps gain in '17)." Zagrean downgraded the rating on

from Outperform to Neutral, while reducing the price target from $105 to $95, saying that all rails would likely "struggle to grow in the double digits" during 2015 to 2017. Moreover, rail stocks were not cheap, either compared to the market or versus history. In the report Macquarie noted, "We now no longer expect that UNP will be able to achieve its 60+/- by full year '19 OR target ahead of time, and see further downside to our growth outlook if in fact more than 50% of the upcoming gas capacity translates into coal displacement rather than feeding new electric demand growth." The EPS estimates for 2016 and 2017 have been reduce by 2 percent and 4 percent, to reflect "coal headwinds lowering the LT growth trend to high-single digits." The analyst upgraded the rating on

from Neutral to Outperform, while raising the price target from $100 to $109, saying that this company was "the last rail standing in double digit growth territory." "KSU becomes our top pick in US rail given the superior growth profile in a space where we continue to see mid single digit downside to LT EPS expectations. We would also pair KSU long against UNP short or GWR short given the potential for earnings surprises and the relative resilience of valuation multiples," Zagrean commented. Macquarie expects the company to achieve "~63 OR by full year '17 OR in line with its "low 60s" target." The EPS estimate for 2017 has been raised by 2 percent, to reflect "stronger progress in operating efficiencies in line with management guidance."