We adjust our models ahead of a first quarter that came with severe weather, pull forward, and growing macro uncertainties that could limit upside over the near term. We broadly lower estimates and see more downside risk if tariffs hold. The U.S. rail group is now below its historical average, though above past recession trough multiples. We favor Union Pacific (UP) for investors looking for U.S. rail exposure.
Where We Stand
We adjust our first-quarter carloadings estimates for the U.S. Class I’s, as total traffic grew 3.9% in quarter one, with outsized growth on the West vs. East. Intermodal was the biggest driver of growth in the first quarter, as international IM volumes were primarily due to a pull forward ahead of tariffs. We believe this will set up an increasingly difficult back half of the year for IM volumes as carriers feel 1) drag effect from pull forward, 2) difficult comparisons, 3) OTR market that gives IM pricing no recovery in sight, and 4) consumer effects from tariffs. Gene Seroka, the Executive Director of the Port of Los Angeles, said in a recent interview that he expects volumes to be at least a 10% drop for cargo imports beginning in July.
We examined rail valuations in the two previous recessions (COVID, GFC) to see trough multiples and timing of recovery. In the GFC, the U.S. group average (on a forward PE basis) fell to 7.0x before returning to its long-term average nine months later. In 2020, the group set a higher trough of 12.5x, before abruptly increasing by the fall. Currently, the group is trading at 14.5x forward P/E, with CSX at 13x and UP at 16x. Valuations have come down five turns from December and every U.S. Class I is now trading below their forward P/E average. We believe there is likely additional multiple compression if tariffs stay in place, and there is the potential for the group to hit 2020 troughs, which would suggest another 2.5 turns of downside risk for the group on average.
We caught up with all the U.S. railroads in the past several weeks. Sentiment (across our whole transports coverage) is increasingly bearish, particularly for the Eastern rails that faced severe weather to start the year. We see it as unlikely that Norfolk Southern (NS) will be able to achieve its full-year guidance targets given the very slow start to the first quarter and so much geopolitical uncertainty; we wouldn’t be surprised to see many names in our coverage pull financial guidance through first-quarter earnings given the uncertainty. CSX has its own internal costs associated with the Howard Street tunnel and Blue Ridge projects, and is the only U.S. Class I with negative volume growth in the first quarter. We continue to favor UP among the rail group for investors looking to U.S. rail exposure; strong re-pricing commentary was shared at our investor dinner and management’s nimbleness should allow them to adjust cost structure in quick fashion should a second-half slowdown materialize.
The Administration proposed port fees of up to $1 million for Chinese vessels in an attempt to boost U.S. shipbuilding. If this went into effect, we believe it could have a significant effect on the North American supply chain and think the following could happen: 1) freight consolidation will lead to increased density at large ports (LA/Long Beach) and hurt volumes of smaller ports (Oakland, Tacoma); 2) some freight may shift to Canadian ports; 3) ocean spot rates would likely rise significantly (reports of COVID-level pricing have been floated but unlikely in our view); 4) congestion at the larger ports may hurt rail service, create bottlenecks, IM carriers benefit from accessorial fees; and 5) it would take many years to move any significant shipbuilding capacity back into the US.
Rail Shipper Survey
Tariffs have dominated conversations with carriers, shippers and investors over the past week. For the second quarter, we asked shippers if they were pulling freight forward ahead of tariffs; 44% answered that they are, up from 26% last quarter.
Weather
First-quarter 2025 saw harsher than typical weather that led to ex-intermodal underperformance in carloads (-1% year-over-year despite easier comps). CSX acknowledged that first-quarter carloads trended below expectations set on fourth-quarter earnings while NS attested to more than 17 facility shutdowns (also highlighted by the public trucking players) and disclosed more than $40 million in incremental weather-related expenses in the quarter (approximately 130bps in Operating Ratio headwind per our estimates). UP fared slightly better with ex-intermodal carloads: approximately flat Y/Y.
Valuation
We lower 2025 and 2026 estimates for all three U.S. rails. We acknowledge additional downside risk to our estimates if tariffs remain in place. The group is now trading below its forward earnings average though above any recession scenarios, in our view. We favor UP for investors that look for U.S. rail exposure.
