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Morningstar | Genesee & Wyoming Sees Solid 2Q Improvement in North American Carloads

In the second quarter, short-line railroad specialist Genesee & Wyoming’s consolidated top line increased 10% to $595 million, not far off our anticipated run rate. Relative to the same period last year, growth came from acquisitions in the U.S. and Europe and solid recovery in carload volumes across most commodity groups, particularly in North America. Total adjusted profitability didn’t deviate drastically from our expectations. For reference, the firm closed the Heart of Georgia railroad deal (short line in the Southeast) in the U.S. and Pentalver (off-dock container services) in the U.K. during the second quarter of 2017. Since our longer-term midcycle revenue and margin assumptions remain largely intact, we are maintaining our $72 fair value estimate.

Excluding acquisitions and foreign exchange, North America revenue increased about 7.5% year over year, driven by healthy core pricing (up 3%) and an acceleration in year-over-year carload volume growth (up 8%), particularly in terms of steam coal, finished steel, aggregates, frac sand, and pulp and paper. Most commodity groups posted growth, save for agricultural products. Conditions continue to look favorable in July, with help from positive U.S. macroeconomic trends. Management expects carloads to increase 5% in the third quarter, which is a solid showing following several years of sluggishness. Australia same-rail sales grew 2% thanks to growing spot coal tonnage in the Hunter Valley region. U.K./Europe organic revenue expanded almost 8% on strengthening bulk shipments of aggregates, higher spot coal activity, and better intermodal pricing, partly offset by port congestion, which pressured intermodal volume.

Excluding U.K. restructuring costs and a few other nonrecurring items, we calculate that G&W’s adjusted operating ratio (expenses/revenue) deteriorated 190 basis points to 82%. Although North America revenue trends accelerated, the segment’s OR worsened to 76.1%, from 74.3% because of mix changes, a lag in implementing fuel surcharges among rising fuel costs, and an uptick in legal expenses. That said, management expects material improvement in operating leverage in the quarters ahead. The adjusted Australia OR deteriorated to 75.2%, from 73.5%, primarily due to heightened expenses related to growth initiatives. The adjusted U.K./Europe OR improved 70 basis points, to 96.4% on the back of healthier revenue generation in the U.K. Management issued guidance for adjusted EPS of $3.80-$3.90 for 2018, which compares with previous consensus near $3.84.