Can Precision Scheduled Railroading Save The Railroads' Third-Quarter Profits?

As the third-quarter earnings season kicks off next week for the Class I railroads, one question will be the degree to which the railroads' safeguard themselves against lower volumes as a result of their cost-cutting measures via precision scheduled railroading (PSR).

Railroads such as Kansas City Southern (NYSE:KSU) have credited PSR, an operating model that seeks to streamline operations and schedules, enabling them to rein in costs, particularly in an environment where rail volumes have trended lower.

Even though rail volumes are down and sub-seasonal for the third straight quarter, "management messaging on cost control and productivity efforts remains quite favorable and is supported by both our checks and intra-quarter proxies for rail cost efficiencies (e.g., regulatory monthly headcount, weekly service metrics)," said transportation analyst Bascome Majors in an October 1 research note from Susquehanna Financial Group (SFG), an investment firm. 

SFG has cut its estimates for earnings per share for most railroads for the third and fourth quarters of 2019 as well as for 2020, with the exception of Kansas City Southern and CSX (NYSE:CSX). 

The lower rail volumes in the U.S. in the third quarter could be a drag on company profits, although the railroads managed to weather the volume downturn in the second quarter through cutting costs. In the third quarter of 2019, U.S. total carloads were down 5.6% year-over-year, worse than the declines seen in the first two quarters of 2019 – -4.2% in the second quarter and -1.8% in the first quarter, FreightWaves reported last week after the Association of American Railroads released its weekly update on North American rail volumes on October 2. A weaker industrial economy, loose truckload capacity and lower bulk loadings have been the primary culprits.

"In 2019, railroads are facing multi-pronged challenges. Fundamental long-term structural changes – including the continued erosion of coal markets; growth in the domestic intermodal and chemical sectors; and the current disruptions to manufacturing, agricultural and international intermodal markets stemming from trade uncertainty and the evolution of consumer purchasing practices – have all required adaptation and renewed focus on basic railroad management and operational principles," said AAR Senior Vice President John T. Gray last week.

As U.S. rail volumes have trended lower this year, railroads such as Union Pacific (NYSE:UNP), Canadian Pacific (NYSE:CP) and Canadian National (NYSE:CNI) have cut their expectations for the second half of 2019. 

But eastern carriers such as Norfolk Southern (NYSE:NSC) face additional potential risk because of lower intermodal volumes and their exposure to falling export coal volumes, according to an October 7 research note from Morgan Stanley (NYSE:MS).

"PSR actions could be an offset but that is probably already in numbers," the Morgan Stanley note said. The note also said the Canadian rails have an edge for potential growth opportunities, although the investment firm has "relatively low expectations within the group."

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