CSX Corporation CSX and Norfolk Southern Corp. NSC traded higher on Friday after Stifel upgraded the two companies from a Hold rating to a Buy rating.
In the recent industry report, Benjamin Nolan analyzed the current state of American railways and offered insight on recessionary trends as compared to the 2008-2009 Great Recession.
CSX shed 9.19% of its value in June, and 18.74% in the last six months; while NSC lost 6.06% in June, and 17.54% in the last six months — vs. the S&P 500 which shed 7.19%, and 16.03% respectively — Nolan still finds value in the current context.
Rail stocks have been re-rated and are now trading at significantly "more attractive multiples" in comparison to previously predicted earnings power, Nolan said.
“However, moving into a softer macroeconomic environment and perhaps a recession, the volumes, prices, and ultimately earnings and cash flows of the rails could be impacted,” Nolan writes, “However, relative to previous cycles, we believe rails should be better insulated as persistently higher fuel prices should enable share gains over trucking. In addition, rails should capture share on currently underutilized carload business being impacted by supply chain congestion.”
However, insulated is not immune. Even while rails are now dealing with rising wages and regulatory costs, Nolan thinks that if the U.S. enters a recession, the effects on the railways will be relatively minor.
“It shouldn't be as bad as 2006-2009,” he said. When carloads ceded to trucking as part of the PSR process were taken into account, the real impact of the crisis of 2008–2009 was more like an 11–12% fall in rail traffic from 2006 levels. Additionally, P/E multiples decreased to 9x from an average of 19x over the previous 10 years.
During the global financial crisis of 2006–2009, the agricultural and energy/coal sectors experienced the least decline, and Stifel has noticed a similar pattern. Automotive and industrial products are two economically delicate areas that historically experience the greatest compression during recessions.
“While we believe this cycle could be similar to the last recession, there are differences which we believe should work in favor of the rails,” Nolan said.
According to Stifel, supply chain congestion is leaving at least 4% of freight demand unmet (current volume vs. 2019 levels), but more likely closer to 8-10%. This means that even if demand declines, volumes should stay high as supply channels unclog.
When rail capacity is available, higher fuel prices should encourage freight (especially intermodal) to move from trucking to rail.
Only industrial categories (metals, timber, autos, etc.) are at risk due to low domestic oil and gas/coal activity and high global grain prices.
Stifel predicts less than a 1% drop in volumes and, in certain cases (CP), volume growth due to typical harvest circumstances, making any recessionary impact on rail volumes much less severe than it was during the previous cycle.
Upgrading The East Coast Rails To A Buy
“Given current multiples and our view that volume compression is likely to be muted, we expect much better multiple support than in the previous cycle particularly given the structurally improved cash flow generation of the companies,” Nolan wrote, “while all the names are cheaper than they were six months ago, we believe the most upside is likely in the East Coast rails which have seen the greatest negative impact to share price and thus we are upgrading CSX shares with a $37 target price (down from $39) assuming 19x our '23 EPS estimate, and NSC shares with a $275 target price (down from $289) also assuming 19x our '23 EPS estimate.”
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