Written by

Jason Seidl, Matt Elkott and Elliot Alper, Cowen and Company

At Cowen and Company, we are adjusting our rail estimates ahead of Q2 2022 results. Continued rail congestion is hampering volume (still below 2019 levels), while prices are expected to be at the same level as Q1.

Diesel prices are reducing our near-term cost-income ratio assumptions, as well as a high cost environment (hiring is increasing). We see tailwinds associated with modal shifts that are driven by energy prices, and we are cautious about near-term network challenges.

Fluidity continues to be tested in the second quarter, although slightly higher than our earlier conservative volume estimates. Quarter-to-date, North American truckload volumes are down 2.3% – and down 2.5% year-to-date – still below 2019 levels (before the COVID-19). The largest drop since the start of the quarter: agricultural products (–7.9%), mainly due to a 42% drop in agricultural products. We note that the winter wheat harvest was lower than expected due to weather effects. Intermodal volumes are -3.8% since the beginning of the quarter, as major bottlenecks near ports persist. As we heard during our recent call on the state of ports earlier this month, the biggest bottleneck over the coming weeks and months will be the rail network. Railroads have struggled to keep up, especially on the West Coast (despite a hiring frenzy), and equipment and labor continue to challenge the network. In our view, this could come at the expense of near-term intermodal growth, as significant delays put shippers in a bind.

That said, US on-road diesel continues to remain high, which we believe will ultimately benefit railroads and IMCs (intermodal marketing companies). Weekly on-road diesel prices have risen nearly 60% since the start of the year and stood at $5.72 per gallon the week of June 19. Diesel prices are passed on to shippers through fuel surcharges. These surcharges are normally tied to an index (usually the US Energy Information Administration’s weekly highway average). Truckers have a small lag (about a week), while railroads see a lag of about 60 days in the recovery (we note that domestic intermodal is about a week lag) depending on the how contracts are written. In general, higher diesel prices widen the gap in total landed prices between truck and rail travel. Indeed, railroads are about three to four times more fuel efficient than their trucking counterparts. Even if a shipper may shift some of its freight to intermodal, apparent network issues may hamper the opportunity for near-term modal shift as the railways continue to increase the number of employees and improve service settings.

We will listen to comments regarding farm volume expectations during the second quarter earnings reports. Headlines surrounding a poor harvest season have raised skepticism about the state of the US agricultural sector. According to the US Department of Agriculture, winter wheat harvest conditions were well below levels seen last year; spring wheat, however, looks much better than last year, which may offset poor winter wheat crop conditions (as seen in the graph above). Plantings of corn, soybeans and wheat all appear to be on or ahead of schedule compared to historical averages. While weather conditions affected the Canadian harvest last year, leading to significant declines in Canadian grain, we continue to monitor the U.S. agricultural sector, which for now appears to be doing better than the big guys suggest. securities. In 2021, agricultural carloads accounted for 9% of total Class I railroad volume, according to our data (see below).

We are modestly adjusting our rail EPS estimates for 2023, while maintaining our multiples for the group. The modest downward adjustment stems primarily from our conservative farm volume assumptions in 2023 (approximately flat year-over-year). After catch-up calls with all Class I management teams, Railroads appear to be in better shape and confident in the improvements discussed during the first quarter earnings reports. We are adjusting our Union Pacific (UNP) estimate lower, due to comments from management at a recent conference where they downgraded the forecast, citing cost pressures from pricing fuel and other high network costs. The railroads continue to be on a hiring spree to improve service, which the Surface Transportation Board has attempted to address. Despite network challenges, railroads have continued to outperform the market year-to-date, down an average of 13%, compared to the S&P’s 19% year-to-date decline (at June 24). As our top rail picks, we continue to favor Canadian Pacific (CP) for the longer-term benefits we see from the pending Kansas City Southern transaction, and Norfolk Southern (NSC) for capacity recovery. of the company to handle more East intermodal freight.