Barclays Cuts Outlook For Rail Sector Heading Into 2016

• Canadian National Railway (USA) (NYSE: CNI) shares are down 19 percent year-to-date, while shares of Canadian Pacific Railway Limited (USA) (NYSE: CP) have plunged 35 percent.
• Barclays’ Brandon R. Oglenski reduced the price targets for both the companies.
• Railroad volumes are expected to contract in 2016, Oglenski stated.

Rail demand has declined by more than 5 percent in the current quarter, with most end-markets exhibiting weakness, analyst Brandon Oglenski said. He added, “We suspect extended holiday shutdowns across the North American energy and manufacturing complex are adding pressure to already weak outcomes.”

The slowdown may result in inventories coming under control. Oglenski pointed out, however, that macro data is lagged and a clear picture is unlikely to emerge until later this winter.

“With such volume pressure at the end of the year, the optics are likely to take a toll on management planning for industrial forecasts, capital budgets and employment targets. This will likely lend to overly cautious if not negative commentary this coming January earnings season,” the analyst wrote.

There is unlikely to be any industrial expansion in North American in 1H16 on account of high inventory levels, continued reduction in energy capex, Fx headwinds and commodity challenges. Oglenski expects industrial growth to be flat in 2016, resulting in tough rail volume comps through 2H16.

Pricing alone would not be able to drive rail EPS growth in 2016. “Early 2016 pricing reads (RCAF ex-fuel) suggest contract rates will be up around 2-3%; but negative mix could likely offset much of the 'core' gains,” the Barclays report stated.

Oglenski expects management teams to aggressively lower costs, mostly with a reduction in employment levels. Nonetheless, we model higher unit cost inflation next year, given our view for underlying demand contraction.

Ratings Maintained, PT Reduced

Barclays maintained an Equal-Weight for Canadian National Railway, while reducing the price target from $56 to $52. The EPS estimates for FY1 and FY2 have been reduced from $4.45 to $4.38 and from $4.65 to $4.50, respectively.

Oglenski maintained an Overweight rating for Canadian Pacific Railway, while reducing the price target from $160 to $136. The EPS estimates for FY1 and FY2 have been reduced from $10.16 to $10.12 and from $11.40 to $10.75, respectively.

Estimates Changed