Weak Employment Could Spell Trouble For Railroads

The ominous signs about the state of the world economy keep rolling in as the U.S Labor Department released the jobs numbers for August last week. Non-farm payrolls posted an increase of 96,000 in the month of August, down from the 141,000 increase in July. The unemployment rate fell to 8.1%, but the decrease was due to 365,000 individuals leaving the labor force causing a decline in the labor force participation to 63.5%.

We think that the decrease in the labor force participation rate is the most troubling statistic as it signals a decrease in confidence as potential employees have left the job search altogether. It is a dire state of affairs when the number for people who leave the labor force is much higher than the number of individuals who find a job.

A group that will be heavily affected by lackluster job growth will be railroad companies. Their revenue growth is dependent on a manufacturing sector which is extremely sensitive to overall economic growth. Below we will look at the impact that a slowdown in the US economy and, consequently the manufacturing sector, would have on Norfolk Southern (NYSE:NSC), Union Pacific (NYSE:UNP) and CSX (NYSE:CSX). Coal Freight

A weak US economy is likely to have affects throughout the world. The United States is a large consumer nation and is the largest importer of Chinese manufactured goods. We think that depressed demand in the United States could lower demand for Chinese goods and consequently decrease Chinese manufacturing, which seems evident from FedEx’s lowered outlook.  Since China’s current coal consumption (which is the largest in the world) has been used to fuel its meteoric manufacturing rise, a manufacturing slowdown will affect coal consumption heavily. This would ultimately slow coal freight volumes across the United states and would have a negative impact on all railroad companies. Coal Freight is Norfolk Southern’s biggest division, and you can examine the impact that a reduction in coal freight will have on the company’s value.

Industrial Freight

The stagnant job market is likely to keep any increases in consumption at bay. The fact that more people left the labor force than found jobs will hit consumer confidence and could also affect corporate confidence as well. Because CEO’s will expect stagnating consumption due to the dire job situation, they could cut output to minimize variable costs and maintain profitability. This decrease in  manufacturing output will impact US carloads of industrial freight and provide downside to the values of railroad companies. For example, if, next year, US carloads of industrial freight declines to 2009 levels (and then maintains an upward trend) we would see 10% downside to CSX’s value.

Intermodal Freight

This is another major driver of the railroad industry that is heavily affected by industrial activity. Intermodal freight services derive revenues from manufactured goods and services that need to be shipped to a destination using more than one form of transportation. As mentioned above, we expect that a stagnant job growth picture can dent manufacturing output. Since this driver is also dependent on manufacturing, we expect that it will also experience downside pressure due to slow job growth. Intermodal freight is Union Pacific’s largest division, and you can assess the impact of this driver by using our tool below.

Overall, the most recent jobs numbers provide a warning sign to railroad companies. The downward pressure on demand created by a lack of jobs and low confidence can hamper US manufacturing and provide downside to railroad companies in the US. If they seek to maintain profitability in the event of a slowdown, they will have to brace themselves starting now.

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