Coal news and updates

Will Weak Coal Shipments Derail Union Pacific?

Just as the multiyear bull market in U.S. stocks begins to display a few strands of gray hair, a handful of bellwether industries are flashing early warning signals that revenue growth and profits may be under pressure.

Rail companies are among those articulating caution to investors. Earlier this month, Norfolk Southern Corp. issued guidance in advance of its first-quarter earnings report on April 29, reducing both its revenue and earnings-per-share outlook. The company cited "downward pressure" on coal shipments -- specifically, significant declines in export coal volume.

Last week, competitor CSX Corp. released its first-quarter 2015 earnings and revised EPS growth for the year from double digits down to the "mid to single-high digits." Management also attributed its reworked forecast to soft global conditions in the export coal market.

Union Pacific , the largest U.S. railroad by revenue, is next up with its first-quarter earnings report this Thursday. Will Union Pacific confirm a trend of decelerating railway results, or will it pull away from its peers?

Why coal still impacts rail results
If you don't follow the industry, you might wonder why coal would play such an outsize role in the earnings of U.S. railroad companies in the 21st century. While domestic consumption of coal has dwindled as cleaner energy sources have come online, coal is very much in demand throughout the developing world, and even in some mature economies abroad.

Thus, U.S. railroads still have considerable opportunity in, and exposure to, the global coal market. And as of late the strong U.S. dollar is turning domestic coal into an increasingly expensive option for nations fulfilling their energy needs. Perhaps "strong" is an understatement, however. Here's a chart of the AMEX U.S. Dollar Index, which tracks the performance of the greenback against a basket of major world currencies:

In the slow-moving currency market, changes like the 22.5% rise in the dollar over the last 12 months often take years to play out. That's a swift and huge tax to pay for importers of U.S. coal. In addition to the currency-driven cost dynamic, Australia, Indonesia, Russia, and Canada have all recently ramped up their coal exports, inflating global supply.

CSX and Norfolk Southern derive 22% and 21% of their annual revenue from coal, respectively, so any further dampening of coal exports will pressure the net profits of both companies. A falloff in foreign purchasing exacerbates thinning domestic coal shipment volume, which has been squeezed by the recent rise of natural gas as an energy alternative.

With a network that sends coal south to Mexico, to the West Coast for export to Asia, and to the Port of Houston for export to Europe, Union Pacific also relies on coal as a significant revenue stream. In 2014, Union Pacific's coal shipments accounted for 18% of operating freight revenue, which equated to roughly 17% of total revenue.

At this level of concentration (though a few percentage points better than its two smaller peers), Union Pacific will likely report a negative impact from coal weakness this week. Shareholders shouldn't be surprised to hear management recalibrate earnings expectations for at least a couple of quarters, if not the entire year.

Yet a few variables could soften the impact for Union Pacific. The company may also benefit from lower fuel prices, which pose both risks and opportunities for rail freight carriers.

In an initial downward fuel trend, railroads roll back the fuel surcharges they assessed on customers as prices rose. In periods of persistently weak fuel prices, however, rail companies realize cost efficiencies on shipping, which provides a tailwind for earnings. CSX, for example, disclosed last week that fuel savings helped the company increase its operating income in the first quarter of 2015.

United Pacific's high level of operating efficiency could also mitigate the drag from any coal weakness. Union Pacific has increased its net income profit margin in each of the last five years from a 16.4% margin in 2010 to a 21.5% profit margin in 2014.

The company has also grown its revenue at a compound annual growth rate of 9% over the same period, with annual sales expanding from $16.9 billion to $23.9 billion. These trends led Union Pacific's net income to climb more than 86% from $2.8 billion in 2010 to $5.2 billion last year.

Impressively, Union Pacific manages to remain roughly twice the size of either CSX or Norfolk Southern by revenue, and yet it's more profitable: CSX achieved a profit margin of 15.2% last year, while NSC posted a profit margin of 17.2%.

Union Pacific should keep up its investing steam
Capital investments are perhaps the most significant factor propelling Union Pacific's profits. Rail companies by law are responsible for most of the track and ties their cars ply, so they tend to show fairly heavy capital expenditures on their books. Union Pacific has aggressively invested in its system -- it has grown capital expenditures at a higher rate than either of its smaller competitors over the five-year window discussed above.
Last year the company spent $1.7 billion upgrading its existing rail network, but it also expended $732 million on additional rail capacity and $1.1 billion on new locomotives and freight cars. UNP's total capital expenditure last year reached $4.3 billion, and it plans to spend at least that amount this year.
The productivity and margin gains the rail operator is garnering from its investments should insulate it against any near-term coal weakness. Should Union Pacific revise its outlook due to coal next week, investors seeking comfort for the long term might want to thumb through the earnings release to double check that the capital investment plan remains unchanged for 2015.

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source: http://www.investopedia.com