UNP Union Pacific Corp

By Laura Stevens 

Railroads face another rough ride this year, as global uncertainty, sliding oil and commodity markets and weakening manufacturing rattle their biggest shippers.

Beginning Tuesday, when CSX Corp. reports fourth-quarter results after the market closes, railroads are expected to deliver dour expectations for the year ahead.

The end of 2015 was hardly smooth, as an unseasonably warm winter, higher retail inventories and industrial weakness extended the year's slide in rail volumes. Intermodal shipments--containers and trailers also carried by trucks--were an exception, but they grew only slightly.

Total U.S. rail traffic declined 2.5% last year to 28 million carloads and containers, according to the Association of American Railroads. For this year, Stephens Inc. analysts forecast a 1.6% decline.

Adding to concerns, China's stock markets have plunged this month amid broader worries about that nation's economy. U.S. companies have been relying on China for sales growth, and further turmoil in that market will likely affect intermodal traffic as U.S. industrial production feels the crunch.

"Starting the year, obviously things don't look very rosy" for railroads, said Mark Levin, an analyst with BB&T Capital Markets, citing the manufacturing slowdown and the increased competitiveness of trucks due to low fuel prices.

Coal is the sector's single largest source of U.S. carloads, accounting for about a third--and currently is also railroads' biggest weakness. Coal volumes have slumped as power plants have switched to natural gas, whose price in 2015 hit its lowest annual average since 1999, according to the U.S. Energy Information Administration.

Coal volumes dipped 12% in 2015 to 5.1 million carloads, according to the AAR. On average, coal used to account for nearly 20% of railroads' revenue, but Mr. Levin now estimates the contribution is closer to 13%.

"Clearly it's a challenging environment for us with low natural-gas prices," CSX finance chief Frank Lonegro said at a conference last month, noting that coal inventories were piling up in both the North and South. Mr Levin added that some plants are running out of room to store coal, prompting them to delay shipments.

Rail shipments are lower nearly across the board, including those of crude oil as domestic producers have pulled back. The trends are so dramatic that investors wonder if railroads will be able to offset volume declines with higher prices and by cutting costs.

"I think flat is the new up," said David Vernon, an analyst with Sanford C. Bernstein.

Union Pacific Corp. and CSX have responded by laying off employees, storing locomotives and reducing operations. Norfolk Southern Corp. closed down one of its three headquarters last year, and said it plans to cut back on some operations affected by coal's decline.

One silver lining is that the reduced rail traffic has enabled the railroads to improve their service. According to an analyst report by Nomura, the average speeds at the four major U.S. railroads were up 15% as the year began, exceeding record 2012 service levels.

Railroads may also be able to command higher rates from shippers who are seeing less in the way of fuel costs being passed through to them, analysts said. And a federal requirement for trucks to install new technology could take as much as 7.5% of the fleet out of commission in the second half the year, according to Stephens, adding an incentive for shippers to use rail.

"You'll probably see a pickup in the back half of the year," Jason Seidl, an analyst with Cowen & Co., said.

Hanging over the industry is Canadian Pacific Railway Ltd.'s $30 billion bid for rival Norfolk Southern. The pursuit has been rebuffed since its disclosure in November, but CP has said its next steps may include launching a proxy fight to take the offer directly to shareholders.

Any deal reached would be followed by a prolonged regulatory review, with the outcome uncertain. Meanwhile, analysts say competitors like BNSF Railway Co.--which has said it might go hunting for a partner--are standing by.

"I think there's a chance that we could see something materialize, but I still say the probability is low," said Justin Long, an analyst with Stephens.

The Week Ahead looks at coming corporate events.

Write to Laura Stevens at laura.stevens@wsj.com

(END) Dow Jones Newswires

January 10, 2016 05:44 ET (10:44 GMT)

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