Rail stocks have been popular in recent years because they were growth stocks that displayed some of the attributes of value investments. Now that seems to be changing at one of the bigger rail success stories, Kansas City Southern (NYSE: KSU).
Kansas City Southern had been reporting very impressive revenue growth in recent years. It reported a revenue growth rate of 12.15% in June 2014, yet over the past year its revenue growth has taken a nosedive into the negative. On June 30, 2015, the Kansas City reported a revenue growth rate of -9.84%.
This is not as bad as it looks because the Kansas City Southern’s revenues were still slightly higher over what they were in June 2014. For the record, the KC Southern reported a TTM revenue of $2.494 billion in June 2014 that grew to $2.509 billion in June 2015.
The true problem here is that the drop in revenue growth seems to be occurring throughout the U.S. railroad industry. Union Pacific (NYSE: UNP) reported a rate of -9.74% on June 30, 2015, while CSX reported a rate of -5.55% on the same day. The other big publicly traded U.S. railroad operator, Norfolk Southern (NYSE: NSC), reported a rate of 4.54% on March 31, 2015.
Railroad Growth Has Stalled
The logical conclusion to make here is that revenue growth in the railroad industry, like that in Big Oil has stalled. The Wall Street Journal blamed the fall in revenue at the Kansas City Southern on a collapse in commodities, particularly energy prices.
The energy revenue at the Kansas City Southern, mostly from oil, dropped by an incredible 46%, The Journal reported. This indicates that the collapse of oil prices is beginning to have a negative impact on the rest of the economy. The Kansas City Southern is highly vulnerable to oil because it provides a direct connection from the American Midwest to Mexico; it transports much less coal than competitors like the Union Pacific.
What’s also interesting is that revenue from the Kansas City’s shipments of industrial and consumer products fell by 7%, and revenue from minerals and agriculture shipments fell by 9%. That indicates weak economies in both the United States and Mexico that were highly reliant upon energy prices.
Coal’s Decline Could Hit Railroads Hard
Oil is not the only energy cash cow in decline at the railroads. Coal shipments have been falling off as power companies switch to natural gas, a change that will accelerate as the Obama Administration’s Clean Power Plan, which greatly restricts power plant emissions, kicks in.
Coal production in the U.S. fell below one billion tons in 2013, the U.S. Energy Information Agency (EIA) reported. That means the amount of coal mined in the United States in 2013 was smaller than in 1993, The Huffington Post noted. This affects railroads like the UP and the Kansas City Southern because coal production in the Western U.S. fell by 2.4% in 2013.
Nor does the near future look that bright for railroads; the EIA expects to see coal production stay flat for the next decade. The International Energy Agency is even less optimistic; it expects U.S. coal demand to decline by 1.7% a year through 2019. That would make for a 6.8% overall decline in coal demand in the United States.
These projections could be optimistic because of growing advances in other energy technologies, including solar and battery storage. News stories indicate that solar could soon disrupt the entire electricity industry in the U.S. and start eating into the demand for coal.
California got six percent of its electricity from solar power in 2014, The Seattle Times reported. One company alone—Elon Musk’s SolarCity (NASDAQ: SCTY)—claims to have 217,000 customers for its solar panels and also claims to be signing up a new customer every three minutes.
An even more disruptive technology could be lithium ion battery storage, which could make solar power competitive by enabling utilities, businesses, and homeowners to store electricity from panels. California is expected to be a major market for such batteries; the state’s Public Utilities Commission wants to create 1.3 gigawatts of storage by 2020.
The true disruption from energy storage could become apparent when Tesla Motors’ (NASDAQ: TSLA) gigafactory comes online in 2017. The factory, a joint venture of Musk’s car company and Panasonic, will produce both energy packs for vehicles and storage solutions for utilities, homes, and businesses. News stories indicate that Tesla is already finding customers for its industrial battery packs, including schools in Escondido, California.
The potential problem for railroads here is obvious; such storage solutions could reduce the amount of electricity utilities have to produce. That would reduce the amount of coal power plant operators need to buy. Utilities and their customers would benefit from reduced costs, but railroads would be stuck with empty cars.
Railroads are going to have a real struggle to remain profitable over the next decade or so. If these transportation companies cannot find something besides coal to fill their cars with, we could be looking at a drop in rail revenues as great as the recent plunge in oil revenues.