Here's Why All Investors Should Pay Attention to Railroads

There are positive signs taking shape in the coal industry according to big participants like Peabody Energy (NYSE: BTU  ) . But railroads CSX (NYSE: CSX  ) and Norfolk-Southern (NYSE: NSC  ) seem to believe that 2014 could be another year to forget for the beleaguered industry. You should hear them out, even if you like coal's prospects.

A rough stretch
Coal has been under pressure for quite some time, suffering from overcapacity, sluggish demand, and low prices. That's on top of natural gas displacement in the utility space and increasing regulatory pressures that make it hard, if not impossible, to build new domestic coal power plants. The now-ending year wasn't kind to coal companies.

BTU Chart

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Globally diversified coal miner Peabody Energy is looking to 2014 for a turn around. For example, the company notes that metallurgical coal prices have started to rise from mid-2013 lows. Part of that is driven by reduced exports from the United States, but helping things along is the fact that met coal projects have been mothballed. So, despite the tough market, the supply side of the equation is starting to look better.

On the thermal side of the business, there's still huge global demand for power generation and Peabody expects coal to play a big part—accounting for 40% of the world's energy supply growth through 2035. Domestically, utilities are starting to work off stockpiles which sets up increased purchases for the right coal basins. That means the Powder River and Illinois basins, which are both relatively cheap and to which Peabody has notable exposure.

Not so fast...
However, CSX and Norfolk-Southern aren't sold on a rosy outlook for domestic coal. According to CSX's CFO, Fredrick Eliasson, "...2014 will be another year where we will have coal headwinds." And Norfolk Southern's President, Jim Squires, reinforces this point, saying that the "coal market continues to face pricing mix and global oversupply challenges." Even Kansas City Southern (NYSE: KSU  ) , which is less exposed to coal revenues, highlighted demand weakness as thermal coal is being displaced by other power options at key utility customers.

Although the train companies view coal only as it relates to their businesses, its worth seeing the coal landscape through their eyes. For example, Norfolk notes that European exports of thermal coal remain at "a cost disadvantage." And that U.S. met coal is still struggling against the "weaker Australian dollar and the possible repeal of the Australian carbon tax..." That's not a problem for Peabody, which sells met out of Australia, but is a big issue for domestic only met miners like Alpha Natural Resources (NYSE: ANR  ) .

And "sluggish [domestic] electricity demand and excess stockpiles in the South, coupled with pressure from natural gas, will challenge volumes into utility plants." Interestingly, CSX's Eliasson isn't quite as glum, believing that coal will face more issues on "the export coal side than on the domestic coal side" in 2014.

CSX believes the domestic inventory overhang will eventually be worked off. Exports, however, aren't going to be so lucky. And CSX is likely to be part of the problem because it wants to reverse price concessions it made to keep coal exporters in the game during 2013. Rising transportation costs will be a tough sell in an already struggling market.

According to Kansas City Southern's VP of Investor Relations, Bill Galligan, the best the railroad could offer was that "not too much more can be done on the negative side for our coal franchise..." And if that's not inspiring enough, the company thinks that the "worst case scenario [and] perhaps the best case scenario come to be the same."

An industry in transition
There's no doubt that coal is in the midst of a very difficult transition. 2013 has been a year to forget, and despite some developing positives, CSX, Norfolk-Southern, and Kansas City Southern are suggesting you should be ready for a tough 2014, too. However, when everyone is most pessimistic is often the best time to start grazing around for good buys. Watch the outlook at the railroads, but consider being an "early" investor in a coal recovery anyway.  

Railroads aren't the only ones voicing expectations for 2014
The market stormed out to huge gains across 2013, leaving investors on the sidelines burned. Especially those that failed to uncover our "Top Stock for 2013" which is up more than 70% year-to-date. However, opportunistic investors can still find huge winners. The Motley Fool's chief investment officer has just hand-picked one such opportunity in our new report: "The Motley Fool's Top Stock for 2014." To find out which stock it is and read our in-depth report, simply click here. It's free!


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