It's Not Time To Buy Railroads: Union Pacific, Norfolk Southern Cut At Barclays

• Union Pacific Corporation UNP shares are down 24 percent year-to-date, while shares of Norfolk Southern Corp. NSC have plunged 29 percent over the same period.
• Barclays’ Brandon R. Oglenski downgraded the ratings for the companies, citing high inventory levels, contracting energy capex and a strong US dollar.
• Despite the plunging share prices, Oglenski believes it is too early to get billing on transports, and rail volume growth may continue to be elusive in 2016.

Analyst Brandon Oglenski said that investors may be keen on acquiring the shares of quality companies while they are seemingly cheap; however, it still appears to be “too early to get bullish on transports.” While investors are aware of the North American industrial headwinds, but the expectation of positive rail volume growth due to easy comps in 2016 may be unmet.

Oglenski elaborated that volume growth could remain under pressure on account of “higher relative inventory levels, another year of contracting energy CAPEX and a strong U.S. dollar.” Moreover, there are concerns surrounding consumer related transport demand due to softer trucking data and decelerating intermodal growth.

In the report Barclays noted, “And the stocks are still not overly ‘cheap’; our simple analysis indicates sector valuations still discount ‘mid-cycle’ outcomes, far from compelling considering continued earnings risk.”

Mix In The Limelight

Oglenski downgraded Union Pacific from Overweight to Equal-Weight, while reducing the price target from $108 to $92. The company’s earnings performance is expected to continue to be impacted by headwinds from declining industrial and energy activity. Direct energy related businesses represented about 7 percent of the company’s total revenue in 2014.

“We understand management is working aggressively to reduce network resources and employee levels to match lower demand, but generally we would like to see the opposite growth driven activity…While ‘core’ pricing gains are likely to remain positive and volume growth could resume in 2016, we see energy and energy related demand as remaining headwinds for the foreseeable future,” the analyst wrote.

Service Challenges Persist

Oglenski downgraded Norfolk Southern from Equal-Weight to Underweight, while reducing the price target from $91 to $76. While fuel surcharges continue to be headwinds, Norfolk’s intermodal market share also appears to be contracting.

“With management discussing continued service challenges in the network, we suspect the lack of improvement could now be impacting top line performance for the company,” the Barclays report stated.

Oglenski also said that coal, which is among Norfolk’s most profitable segments, faces significant headwinds due to the current global macro conditions. “[W]e think the company’s current stock valuation does not fully reflect potential downside,” he added.