Coal isn't dead yet and the railroads are loving it

By January 2016, some investors believed that the final nail had been hammered into the coffin of the American coal industry, but then something surprising happened.

According to research from UBS, coal prices and production, along with the stocks of companies involved in coal, began to slowly turn around. This came as natural gas prices rose for the first time in years, taking the pressure off coal.

It is still expected that the long-term prospects for coal are grim. However, when Donald Trump was elected president in November, new life was breathed into the coal story with investors looking forward to possible deregulation of the energy industry.

And coal companies aren’t the only ones to benefit. These developments have been a huge tailwind to railroad companies who make a nice profit margin off transporting coal, but have lost much of that revenue in recent years.

In a recent note, UBS reported the decline in coal’s importance to railroads when production was lower:

“In 2011, coal made up ~31% of revenue for CSX corp. and NSC (Norfolk Southern) and ~21% of revenue for UNP (Union Pacific). As shown in Figure 1, below, coal fell to ~12% of revenue for UNP, ~17% of revenue for CSX, and ~15% of revenue for NSC in 2016.”

But now, with coal making a comeback, as well as other economic developments, UBS is more optimistic about rail:

“We have a broadly positive view on the railroad stocks based on our expectation of favourable cyclical improvement in rail volumes in 2017, stronger pricing in 2018, and the potential for boosts to EPS and free cash flow if US tax reform is enacted.”

The bank’s favourite rail stocks are CSX and NSC, in part because of their exposure to coal.

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