Weaker Volumes Drove Down Genesee & Wyoming Inc.'s Earnings

By Markets Fool.com

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Sluggish macroeconomic conditions continue to weigh down rail volumes, which causedGenesee & Wyoming's (NYSE: GWR) financial results to slump in the third quarter. But as with most challenges, opportunities arise that might not have emerged otherwise. That certainly seems to be the case right now, enabling the rail company's acquisition train to pick up speed.

Genesee & Wyoming results: The raw numbers

Metric

Q3 2016 Actuals

Q3 2015 Actuals

YOY Growth

Revenue

$501.0 million

$546.3 million

(8.3%)

Adjusted net income

$55.4 million

$63.7 million

(13%)

Adjusted earnings per share (EPS)

$0.95

$1.10

(13.6%)

YOY = year over year.Data source: Genesee & Wyoming.

What happened with Genesee & Wyoming this quarter?

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Volumes slumped across the board:

  • North American revenue slipped 1.4% to $310.2 million due primarily to lower fuel surcharges and weaker shipments. Overall, shipments were down 4.2%, with coal shipments accounting for roughly half of the decline while pulp and paper, minerals and stone, and metal carloads also fell. These weaker carloads pushed down operating earnings by 3.8% to $87.2 million.
  • Revenue in Australia slumped 11.2% to $54.2 million due to the loss of a fixed-fee payment associated with an iron ore mine that closed as well as lower shipments. Carloads were down 10.3%, due to weaker metallic ore and agricultural product shipments. These factors caused operating income to plunge 70.7% year over year to $4.4 million.
  • The U.K./Europe segment was even weaker, with revenue declining 20% to $136.7 million. That said, foreign exchange fluctuations due to the Brexit uncertainty shaved $18.1 million from the top line. After adjusting for that impact, revenue would have only decreased 10.5%. Driving that drop was a 3.4% decline in carloads, due primarily to weaker coal and coke traffic as well as a decrease in intermodal shipments. These issues caused operating income to crash 99.8% year over year to just $0.3 million.
  • One a more positive note, free cash flow generation was a robust $187.6 million, up 29.8% from the year-ago period.
  • The company continues to put that cash flow to use via strategic acquisitions, including two over the past couple of months. In August, it agreed to acquire P&W Railroad for $126 million in cash. Meanwhile, last month it announced an A$2 billion transaction to acquire a rail company in Australia, which it plans to combine with its existing Australian subsidiary and create a joint venture with a leading global infrastructure company.

What management had to say

About the company's results, CEO Jack Hellmannsaid:

Our financial results for the third quarter of 2016 were consistent with our expectations with reported diluted EPS of $0.98 and adjusted diluted EPS of $0.95. In North America, better than expected steam coal shipments combined with strong cost controls yielded a better than expected operating ratio of 71.9%. In Australia, financial results were in-line with our outlook as we continued to effectively manage costs in the weak commodity environment. In the U.K./Europe, our financial results in the first full quarter since we restructured the U.K. coal business were below our expectations for three reasons: congestion in the port of Felixstowe which weakened U.K. intermodal shipments; unscheduled reductions in U.K. infrastructure services; and weak performance from continental European intermodal.

All things considered, Genesee and Wyoming delivered a solid quarter, mainly because of its ability to control costs. This outperformance due to cost savings was the story for rail companies during the third quarter. Rival CSX (NASDAQ: CSX), for example, noted that its strong cost performance enabled it to capture $112 million of efficiency gains during the quarter. As a result, CSX delivered an improvement of 70 basis points in its operating ratio to 69%. Norfolk Southern (NYSE: NSC), likewise, drove its costs down to mute the impact of the headwinds that have slowed down shipments. As a result, Norfolk Southern's costs declined 10%, while its operating ratio improved to 67.5%.

Looking forward

Genesee and Wyoming has a lot on its plate right now. According to Hellman:

Looking to year-end, our priorities by region are threefold. In North America, we remain focused on maximizing cost efficiency amid an uneven economic environment. In Australia, we expect to close on the recently announced acquisition of Glencore Rail and the concurrent issuance of a 49% equity stake in our Australian subsidiary to Macquarie, in a transaction that yields a highly competitive Australian growth platform going forward. In the U.K./Europe, we continue to restructure the continental European business and to reduce costs in the U.K. Despite the weak third quarter, we see a clear path to improvement in the U.K./European segment as we finish the year and enter 2017.

In addition to those priorities, Hellman said that the company has a "significant pipeline" of acquisition opportunities to expand its global rail footprint. Needless to say, the company clearly sees the current challenging market as an opportunity to grow and position itself for the next up cycle.

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Matt DiLallo has no position in any stocks mentioned. The Motley Fool recommends CSX and Genesee and Wyoming. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.