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Weather issues have severely impacted rail in Q1: RBC Capital Markets

TORONTO, Ont.—Weather issues have had a severe impact on rail carriage in the first quarter of 2014, according to RBC Capital Markets Analyst Walter Spracklin, in his RBC Compass report analyzing rail activity for Q1.

A “challenging operating environment drives negative estimate revisions. We are reducing our Q1/14 forecasts for the Class 1 railroads (except for KSU) as extreme temperatures and winter storms have slowed the pace of freight activity across North America capping revenue and efficiency potential in the quarter,” Spracklin noted.

“We expect the market to discount higher costs related to weather events in the quarter. Accordingly, we expect management insight on the following items to determine near-term investor sentiment on railroad shares: 1) carriers’ opportunity to recoup volumes in upcoming periods; and 2) the health of underlying fundamentals in core businesses,” said the report.

Total freight volumes were flat through eleven weeks of the first quarter as a +0.8%Y/Y increase in U.S. traffic was offset by a -3.6%Y/Y drop in Canadian carloads. Consistent with 2013 trends, most carriers continue to post the strongest gains in shipments of petroleum products, which we attribute to the ongoing expansion of crude-by-rail operations. Grain and intermodal have also been a source of growth for US railroads, while the Canadian carriers have collectively posted volume declines in all categories (excluding coal and petroleum products).

“Overall, carload trends have fallen short of expectations to date in Q1/14; however, we believe the weak volume trend can be largely explained by weather-related issues that have impeded rail operations during the period,” said Spracklin.

Operating performance was significantly impacted by severe weather conditions in the first quarter as all six large Class 1 railroads posted materially weaker metrics on a year-over-year and sequential basis.

“We believe slower train speeds and higher dwell times have negatively affected network productivity driving up fuel, materials, and employee over-time costs for all carriers,” the report noted.

Average train velocity and terminal dwell times have also been impacted, noted the report.

“It is important to consider that CNR and CP do not apply the same methodologies to calculate these metrics; however, we believe comparisons to prior year and prior quarter results are representative of each railroads’ operating trends in the period,” said Spracklin.

“A high volume of winter storms on the Eastern U.S. seaboard has caused CSX and NSC’s networks to slow

significantly in the first quarter. Apart from the Canadian carriers, these railroads’ operating metrics have weakened the most year-to-date with double-digit increases in average dwell time and high-single / low-double digit declines in average train velocity relative to both prior year and prior quarter performance,” said the report.

In the first quarter, most Class 1 railroads have added assets to their network to combat lower utilization due to operating constraints. Relative to prior year levels, CSX has posted the strongest increase in cars on-line of the carriers in our coverage space as the weekly average is up +7.1%Y/Y, while most other railroads have reported low single-digit growth. We expect the increase in cars on-line to inflate rent and materials expenses in Q1/14 results.

“We believe weather continues to hamper rail operations across North America. Given the severity of network congestion today, we expect a full recovery to be several weeks out contingent upon high levels of cooperation across the supply chain and infrequent weather disruptions,” said the report.

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