Stay away from the railways until volumes improve: J.P. Morgan

, Economic

North American railways implemented “impressive” cost controls in the first quarter but these will be difficult to sustain, say J.P. Morgan analysts.

The railroad industry is beginning to see a few small signs of improvement but analysts at J.P. Morgan say investors should stay away from the sector until they see a significant increase in volumes.

North American railways implemented “impressive” cost controls in the first quarter but these will be difficult to sustain as operating comparisons get more difficult in the second half of the year and weaker volumes make it harder to squeeze more productivity out of employees, according to the bank.

“(We) would be broadly cautious on the group heading into the summer investment conference series where we expect management teams reaffirm weak volume trends and a challenging outlook — historically a negative catalyst after a substantial rally,” J.P. Morgan analyst Brian Ossenbeck wrote in a note to clients.

Ossenbeck said he’s taking a selective approach to rail stocks due to elevated valuations and weakness in end-market demand. Even higher energy prices could prove to be a headwind, worsening the railways’ operating ratios as fuel costs rise.

The railways are also competing more aggressively for shrinking volumes, particularly in Canada, Ossenbeck said.

“We think competition intensified in Canada as CP employs dynamic pricing for customers who own equipment and CN defends selected market share,” he wrote.

Ossenbeck gives both Canadian Pacific Railway Ltd. and Canadian National Railway Co. a neutral rating with price targets of $204 and $82 respectively.

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