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The Ratings Game: After rail strike averted, chance for ‘freight recession’ should still spook investors, analysts say

Railroad operators CSX Corp. and Norfolk Southern Corp. were hit with a downgrade from Susquehanna on Wednesday, with analysts citing bigger profit risk to rails operating in the eastern U.S., lingering potential for a work stoppage and a broader weakening of the economy.

“As we look toward 2023, macroeconomic clouds continue to gather, the pressure to improve rail service hasn’t eased, U.S. rail labor costs are due a markup for the tentative union agreements, and the risk of a work stoppage could arise again in late November and early December,” Susquehanna analysts Bascome Majors, Jeff Johnson and Harrison Bauer wrote in a research note on Wednesday.

The analysts later added: “Rails shares aren’t yet priced for a freight recession.”

Rail unions have reached a tentative deal with the nation’s biggest railroads to avoid a strike that could have gouged the U.S. economy and threatened shipments for grain, coal, chemicals, cars and other merchandise. But some reports said the unions’ rank-and-file remained unenthusiastic about the terms. Before the tentative agreement, many workers remained concerned about what they said were ungenerous sick-time policies and exhausting schedules.

The Susquehanna analysts downgraded CSX
CSX,
+1.21%

and Norfolk Southern
NSC,
+1.15%

to the equivalent of a hold rating from a ‘buy’ equivalent, and cut their price targets on both stocks. Their price target on CSX is now $29, down from $35, and for Norfolk Southern, the target stood at $218, down from $275.

The analysts also cut their price targets for Canadian National Railway Co.
CNR,
+1.73%
,
Canadian Pacific Railway Ltd.
CP,
+0.29%

and Union Pacific Corp.
UNP,
+2.50%
,
while maintaining their ratings on those stocks, writing that the Canadian railroads had less exposure to any impact from negotiations with unions. The Susquehanna analysts lowered their 2022 and 2023 earnings-per-share forecasts for all five companies, and wrote they now expected earnings for the rails running in the eastern U.S. to decline next year, compared with earlier expectations for growth.

Don’t miss: Why a possible railroad strike would cripple the supply chain, stoke inflation

Both CSX and Norfolk Southern operate in the eastern half of the U.S., where the analysts said rail service speeds remained slower year-over-year despite expanding crews. While the analysts said speeds for both rail operators strengthened in the third quarter, they expected CSX’s earnings per share next year to drop to $1.65, from expectations for $1.77 this year. For Norfolk Southern, they expected 2023 earnings per share of $12.50, down from $13.07 in 2022.

Rail service has suffered from supply-chain bottlenecks and a lack of chassis to move railcars. Analysts have also been concerned about inflation’s impact on demand for goods.

CSX stock rose 1.3% on Wednesday. Norfolk Southern gained 1.4%. Shares of the companies reached two-year lows a day earlier, after UBS also downgraded both stocks, citing a ‘deteriorating’ economic backdrop and saying 2023 earnings-per-share estimates were too high.

CSX stock is down 27% this year, and Norfolk Southern shares are also down 27% in that time. By comparison, the S&P 500
SPX,
+1.51%

is down 22%.

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