Rails earnings preview: Fuel surcharges could lead to margin beats
jimfeng

UBS is positive on the rails sector just ahead of the earnings season.
Crucially, analyst Thomas Wadewitz said the fuel benefit to operating income could be 2X to 3X larger than the tailwind seen in Q2. During that quarter, growth in fuel surcharge outpaced growth in fuel expense to drive 3% to 5% growth in operating income for the U.S. rails and 8% to10% growth for Canadian rails. 
Looking at Q3, UBS models for an even higher fuel surcharge revenue, given the two-month lag in the surcharge mechanism for carload shipments. At the same time, fuel expense are seen being lower given the reduction in fuel prices from the prior quarter.
"We believe this will produce a larger 3Q operating income tailwind y/y ranging from 9%-11% for Eastern rails and 15%-18% for UNP, CP, and CN. We also calculate that the 3Q fuel impact to operating ratio performance should be positive y/y, unlike the headwind the rails experienced in 2Q. 2023 setup for Canadian rails appears more constructive than for U.S. rails."
UBS continues to prefer Canadian rails Canadian Pacific Railway (CP) and Canadian National Railway Company (CNI) due to the setup for volume outperformance in 2023 from easy grain comparables and synergy benefits. CP and CNI are also said to have a more defensive business mix and are supported by idiosyncratic drivers that the U.S. rails lack at the moment. For U.S. rails CSX Corporation (NASDAQ:CSX), Union Pacific (UNP) and Norfolk Southern (NSC) - UBS says the upside to 2023 volume estimates is dependent on the extent to which they can recover market share lost to trucking, which would buffer the impact from a weaker macro.
Dig into the latest update on weekly U.S. rail traffic.