Factors That Could Pull Down The Value Of US Railroad Companies In The Short Term

by Trefis Team
Union Pacific Corporation
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In our previous analysis – Factors That Could Drive The Value Of US Railroads Stocks In The Short Term – we had talked about how the strengthening of the US economy, coupled with the favorable working environment created by President Donald Trump, could drive the coal and industrial shipments in the country, thereby enhancing the value of US railroad companies. However, there are certain factors that could weigh down on the positive valuation of these railroad companies in the short term. Below, we briefly discuss the key factors that could cause a downside to the value of US railroad companies.

See Our Complete Analysis For Union Pacific Corporation Here

Anticipated Decline In The Automobile Sector

The US is the world’s second largest market for vehicle sales and production. The automobile sector accounts for roughly 3%-3.5% of the country’s Gross Domestic Product (GDP), producing almost 12 million passenger vehicles and 17.5 million light vehicles in 2016. Thus, the industry is an important factor that drives the country’s economic development and growth of other related sectors. From the graph below, we can see that the motor vehicle and parts shipments dropped sharply from roughly 23 million tons in 2011 as an after effect of the economic recession of 2009-2010. However, they have recovered gradually in the last five years, driven by the recovery in the US economy and the introduction of new models and technology by manufacturers.

Source: Annual US Railroad Traffic, Association of American Railroads (AAR)

However, this trend has been reversed since the beginning of 2017, as the demand for light vehicles has slowed down, despite large discounts being offered by manufacturers to clear their previous inventories. While there are several reasons to justify this decline, the most prominent one is the replacement rate. In other words, the pace at which cars or trucks are being purchased is not the same as the pace at which they are being replaced. Hence, there has been a void in the demand for these vehicles, which is visible from the decline in their sales year-to-date.

Since the railroad sector is closely correlated to the automobile industry, it has also witnessed a plunge in its shipments through the year. According to the latest rail traffic data by the Association of American Railroads (AAR), the US motor vehicles and parts shipments stood at 0.75 million carloads year-to-date, which is 7.2% lower compared to the same period of last year. While the the damages caused by the recent hurricanes could provide some short-term opportunities for the light vehicle market, the full year motor vehicles and parts shipments are likely to come in lower compared to the last year. Besides, this trend is expected to continue into the coming quarters, which is expected to pull down the current valuation of the US railroad companies.

Volatility In Crude Oil Markets

The commodity markets have been facing its worst-ever downturn over the last three years, wherein crude oil prices have plunged from over $110 per barrel in mid-2014 to $26 per barrel in early 2016. However, oil prices have started to show some resilience since the beginning of 2017 as the Organization of Petroleum Exporting Countries (OPEC), along with some Non-OPEC members, have implemented production cuts of 1.8 million barrels per day, pushing up the oil prices. Currently, the Brent oil price stands at $62 per barrel, which is the highest level seen in the last two years. That said, the commodity markets have not completely recovered from the downfall and continue to rely on several external factors. As a result, the markets continue to be volatile, making it difficult to predict the course of oil prices.

Since petroleum and petroleum products form a sizeable portion of US rail shipments, the sustained fluctuations in commodity prices could result in lower shipments for the railroad companies. This would, in turn, weigh heavily on their top-line as well as bottom line, pulling down their valuation in the near term.

Brent Crude Oil Prices 

Source: Bloomberg

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