Q1 rail earnings preview: Service metrics, headcount, macro uncertainties

A photograph of a freight train traveling by a rail crossing. A guard rail on the road is down to protect motorists.

As the Class I railroads gear up for earnings season this week and next, commentary about the first quarter of 2022 will likely include discussion about how the railroads’ recent hiring initiatives will translate into improving service metrics in the second half of the year.

However, a potential softening in freight transportation demand plus higher inflation rates are market factors that could weigh on the second half of 2022. Meanwhile, the railroads also face potential regulatory scrutiny because of lackluster rail performance in the first quarter.

“The rails had another noisy quarter, with service levels and volumes still lagging for most, but recent success in hiring front-line employees supports our thesis that 2Q and 3Q will finally be the super-seasonal snap-backs we’ve been waiting for since last summer,” said transportation analyst Bascome Majors in an April 7 note from Susquehanna Financial Group.

The Class I earnings season kicks off this week, with CSX (NASDAQ: CSX) reporting results on Wednesday afternoon and Union Pacific (NYSE: UNP) reporting on Thursday morning.

Next week, Canadian railway CN (NYSE: CNI) will report first-quarter 2022 financial results on Tuesday while Norfolk Southern (NYSE: NSC) and Canadian Pacific (NYSE: CP) will release results on April 27. 

Railcar lessors and equipment manufacturers are also reporting quarterly results: GATX (NYSE: GATX) will release results on Wednesday morning, while Wabtec (NYSE: WAB) will report results on April 27.

In January’s fourth-quarter 2021 earnings calls and throughout the first quarter of this year, several Class I railroads said they have been more aggressive in hiring train and engine employees and filling trainee classes. Those new classes will be ready to boost network capacity in the second half of the year. 

UP is “recruiting heavily to alleviate crew shortages in certain locations and have modified our recruiting strategies to attract more applicants. We are aggressively hiring and streamlined our onboarding process to get new hires on the job faster,” said Kenny Rocker, UP executive vice president for marketing and sales, in an April 11 service update. As of early April, UP had 450 employees in training poised to graduate in the early summer.

Indeed, slower train speeds and longer dwell times in the first quarter of 2022 have been blamed partly on staffing shortages due to the COVID-19 pandemic and the omicron variant.

A comparison of the weekly average train speeds for U.S. operations of the Class I railroads over three years. (FreightWaves SONAR) To learn more about FreightWaves SONAR, click here.
The rail terminal dwell time system average is a weekly average. It tells how many hours a railcar may reside at the largest 10 terminals. It excludes cars on run-through trains. (FreightWaves SONAR)

“CSX’s operating teams are working hard to get our merchandise performance measures back to the record levels that we achieved prior to the pandemic. We’re investing in our people, our network and our customer service platform to further improve service and expand capacity,” Farrukh Bezar, CSX senior vice president of marketing, said at the North East Association of Rail Shippers conference in Baltimore earlier this month.

But while the additional crews could improve service performance in the second half of this year, investors will also be watching how macroeconomic conditions affect rail volumes and companies’ performance for the remainder of the year.

“The key to the rails’ show-me story remains volume growth, since revenues must carry the load as more than a decade of profit growth led by pricing and PSR [precision scheduled railroading] reaches maturity. Our eyes are wide open to the recent signs of softening in retail-centric truckload … but we believe rail’s heavy industrial/commodity customer mix and fuel/cost savings in retail-centric intermodal will help rails buck this trend at least through 2022,” Majors said.

So far, domestic intermodal volume (blue) has held up better than dry van truckload tender volume (green) and long-haul truckload tender volume (orange). (FreightWaves SONAR)

Although the trucking market appears more vulnerable to a potential freight transportation recession, the railroads’ role in carrying bulk commodities such as coal could help support the freight rail market.

“The sequential step up in pricing expectations indicates continued tightness across the North American supply chain and foreshadows strong rail pricing in 2022, as carloads continue to track below pre-COVID levels,” said Cowen transportation director Jason Seidl in an April 5 note. “Year-to-date, North American carloads are -2.9%; while signs of congestion may show early signs of easing (some loosening at the ports) the rails should be able to lock in strong pricing … particularly as potential tailwinds may position the rail group well given the current macro-environment.” 

However, if macroeconomic uncertainties linger and rail volumes don’t increase considerably, that could eventually put pressure on the rail market.

The first quarter of 2022 “is now the third quarter in a row that economic confidence has declined sequentially [among shippers polled by Cowen], which may partially be attributed to the significant headwinds rail shippers are facing across all modes of transportation, on top of recent events in Eastern Europe that is increasing economic uncertainty in North America.”

Said Majors: “Our biggest concerns on the rails remain a broader recession whose volume pressure overwhelms or reverses their favorable market exposures, while simultaneously driving multiple compression for this relatively resilient group. … If 2Q volumes fail to show the super-seasonal build we’re looking for without good reason, we’ll need to revisit our bullish rail thesis and the closer-to-peak-than-trough target multiples underwriting it.”

As investors tease out how macroeconomic conditions could impact rail volumes and companies’ financial performance, the potential for additional regulatory scrutiny is serving as a backdrop.

Shippers have been arguing that PSR has been partly to blame for the first quarter’s service delays. They have told the Surface Transportation Board that the staffing cuts done in the name of PSR contributed to service delays as demand ramped back up. 

STB in turn is holding a public hearing on April 26 and 27 — in the middle of the Class I railroads’ earnings season — to ask the Class I railroads why service metrics have deteriorated.

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