Cowen: 2Q22 shipper surveys say…

Written by

Jason Seidl, Matt Elkott and Elliot Alper, Cowen and Company

According to Cowen and Company’s railroad equipment survey for 2Q22, it appears that hoppers and gondolas have seen improved demand compared to 1Q22. Containers and center beams are down from 1Q22.

The outlook for rail car orders and rail prices was up in the second quarter of 2022, according to Cowen and Company’s recent rail equipment and rail shipper surveys. Details follow, along with information on Class I railroads, before earnings.

The order outlook for the shipper sub-group of car buyers increased in the second quarter. This is likely due to signs of falling steel prices and the industry’s continued fleet tightening, partially offset by interest rate hikes and economic uncertainty. We still expect a strong production cycle, although the pace is a function of macro variables.

Expected rail price increases were 4.6% in the second quarter, down 40 basis points sequentially but above our survey’s five-year average. Business growth and the economic outlook slowed further this quarter, with nearly 90% of shippers expecting a recession. Some 58% of shippers responded that rail service affects their shipping decisions.

What the Rail Equipment Survey Results Tell Us

(Photograph courtesy of Greenbrier)

Shippers’ order expectations are higher than they were in our Q1 2022 survey. It looks like we’ve finally reached a point where the railcar industry fleet is tight enough and pockets shortages are large enough to drive increased manufacturing orders, despite a murky macro outlook, at least by shippers faced with dwindling availability of some cars from lessors. Steel, which has been a major contributor to the industrial fleet tightening of the past two years, is showing signs of easing. This could reduce the cost of purchasing a newly manufactured wagon. On the other hand, interest rates are higher, which could negate the benefits of steel moderation. While we expect spot leasing rates to continue their streak of seven-quarter sequential quarterly improvements through 2023, if steel prices decline materially and the easing looks long-lasting, manufacturing orders could experience noticeable increases, which could eventually lead to a moderation in the dynamics of rental rates. next year. All other things being equal, the survey results are positive for Greenbrier Enterprises (GBX), FreightCar America (RAIL), and private manufacturer Steel national carand in a lesser extent Trinity Industries (TRN).

Survey Summary

With respect to ordering activity, we consider four key metrics: (1) the percentage of “all participating shippers” who will or could order railcars; (2) the level of belief about the order (the split between “yes” and “maybe”) within this “all participating shippers” group; (3) the percentage of “same shippers” who will or will be able to order cars; and (4) the level of belief about the order (the split between “yes” and “maybe”) within this group of “same senders”. In our Q2 2022 survey, the first three indicators improved, while the fourth deteriorated.

About 52% of all shippers surveyed said they will or could order railcars in the next 12 months, up from 47% in the first quarter of 2022. About 49% now say they don’t plan to order wagons, compared to 53% in our first -quarterly survey. Of the 52% of total shippers planning to place orders in the next 12 months, 67% said “yes” they plan to place orders, up from 65% in the first quarter; and 33% answered “maybe”, compared to 35% in 1Q22.

On a same shipper basis, approximately 51% of same shippers in Q2 2022 said they will or could order railcars, compared to 40% in our Q1 2022 survey.

What the rail survey results tell us

Shippers expect rail fares to rise 4.6% over the next six to 12 months, down 40 basis points from last quarter’s survey. The result of 4.6% is above the survey’s five-year average of 3.6% and above the survey’s long-term ten-year average of 3.7%. We view the sequential decline in prices as a near-term negative for the group, particularly after the railroads all cited a high cost environment. Union Pacific (UNP) revised its forecast downward at a recent industry conference, citing higher inflationary and network costs. Year-to-date, North American loadings are down 2.5%. Railroads have suffered from poor service metrics that hampered volumes in 2022. While railroads have been hiring, 69% of shippers said they struggled to hire employees (although a sequential improvement of 2 %).

Business growth expectations fell 70 basis points sequentially to 2.1%, and below the survey’s six-year average of 2.6%. The percentage of shippers expecting their number of employees to increase over the next 12 months has dropped 13% from last quarter’s response. Only 8% of shippers said they were more confident in the direction of the economy today than they were three months ago – the lowest ever for the survey, and notably below from the survey average of 46%. This is now the fourth consecutive quarter that economic confidence has declined sequentially. A staggering 87% of shippers believe we are heading into a recession.

For the first time, we asked shippers if rail service had an impact on their shipping decisions; 58% answered “yes”; this had an impact on their decisions. As we previously highlighted on our port condition call, poor rail service has been a bottleneck in the North American supply chain for the past few months. Although the railways have looked at hiring to improve service, it can take four to six months for railway employees to step up. Some 34% of shippers switched from highway to rail in the last quarter, up 5% sequentially.

We also asked shippers if fuel costs change modal choices; 61% of shippers said fuel costs are changing modal choices, in line with our expectations, given that the price of US on-road diesel has risen about 60% since the start of the year. Overall, we view the two new questions we posed to shippers as net-neutral, given that rail service has been a negative catalyst for Class I railroads, while fuel cost has been a positive catalyst. While North American railcars are still around 6% below pre-COVID levels, we believe that if rails can clean up service metrics, volumes could be on the upside, given our assumption of the high fuel costs in the medium term.

Rail stock preview before earnings

Rail congestion continues to hamper volumes, while prices are expected to be about the same as in the first quarter. Diesel prices are reducing our near-term cost-income ratio assumptions, as well as a high cost environment (increasing hiring); we see tailwinds associated with modal shifts, driven by energy prices, while we are cautious on near-term network challenges. Given a continued decline in economic outlook and confidence, coupled with lower price growth, we view our survey as negative in the near term for the rail group. That said, we continue to favor Canadian Pacific as our top choice for rail exposure (for the longer term benefits we see from waiting Kansas City South merger operation) and South Norfolk (for a recovery in the company’s ability to handle more eastbound intermodal freight).

Key words: Canadian Pacific, Cowen and Company, CP, FreightCar America, Kansas City Southern, National Steel Car, Norfolk Southern, Opinion, The Greenbrier Companies, Inc, Trinity Industries, Union Pacific
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