Bad News Sends Railroads and Industrials Plunging

Despite mixed news on employment that left the Dow Jones and S&P 500 basically flat for the second day this week, transportation and heavy equipment stocks were down sharply on Thursday. Investors were reacting to evidence that freight volumes will be lower than expected this quarter, as well as a report from the Federal Reserve Bank of Philadelphia that manufacturing in that region is down.

Railroad blues
Railroad operator Norfolk Southern (NYS: NSC) slashed its guidance after markets closed on Wednesday, leading to a surge in after-hours trading, and a weak day of trading on Thursday, with shares closing down 9%. Norfolk Southern cited the low volume of coal shipments as the major problem, and projected that the company would lose $120 million in revenue, compared to the third quarter of 2011.

Weakening demand for coal is a structural problem for the railroad industry, as cheap, clean natural gas becomes the energy source of choice for new power plants. Investors and analysts expect that slack coal shipments will hurt the entire industry, and UBS downgraded a spate of railroads, including CSX Corporation (NYS: CSX) , which closed Thursday down almost 6%.

Norfolk Southern and CSX lead the industry in terms of revenue derived from coal shipments, at around 30% each. Both have strong exposure to dirty Appalachian coal that is increasingly falling out of favor with regulators and power plants. Railroads like Canadian Pacific (NYS: CP) , which derives only 10% of revenue from coal, fared much better. Canadian Pacific avoided the UBS downgrade, and fell only about 3%.

Not too sunny in Philadelphia
A report from the Federal Reserve Bank of Philadelphia showed the region's manufacturing base has shrunk for a fifth consecutive month. The Philadelphia branch is the nation's second to release this kind of regional data, and the New York Fed released similarly gloomy numbers earlier this week. This points to a national trend of declining manufacturing activity, which has led to sharp declines in heavy equipment manufacturers.

Natural gas engines are becoming popular in construction equipment, thanks to the price difference between cheap natural gas and other fuels, and that's returned big gains for natural gas engine designer Westport Innovations (NAS: WPRT) . However, shrinking manufacturing activity may reduce the need for capital equipment. These fears have prompted price retreats, not only in heavy equipment manufacturers like Terex (NYS: TEX) , down 4%, but also for Westport, down 6% on Thursday. Westport's high valuation, trading for 6.7 times sales, or more than four times the S&P 500 average, reflect extreme enthusiasm on the part of its investors, so even minor pullbacks in expectations can lead to drastic price movements.

With so many companies being affected by cheap natural gas, it's important to remember that, despite increased supply in North America, prices will eventually rise as demand picks up. One Motley Fool analyst predicts that turning point could come before 2014, and has identified one stock you need to own before it does. This report is free, but it's only available for a limited time, so get your copy today.

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