NEW YORK (TheStreet) -- Working on the railroad doesn't pay well these days. Kansas City Southern (KSU) - Get Report fired off a sector warning Monday when it cut its 2015 revenue outlook due to lower energy prices and Mexican currency weakness. The guidance sent the railroad's shares plummeting 7% and caused most of the other large rail stocks to drop at least 3% apiece.
The warning is a derailment of sorts for a company that has been an overachiever in recent years. Kansas City Southern's major exposure to Mexico, a high-growth market, allowed it to increase volumes faster than its peers coming out of the recession.
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issues -- notably its considerable exposure to the peso -- are unique to that company. But other factors including weaker than expected growth in shipments of crude and fracking supplies, declining coal revenues and a loss of fuel surcharges are hitting all industry participants.
The guidance "highlights several risks that the overall rail sector currently faces," Cowen & Co. analyst Jason H. Seidl wrote. Coal in particular is a trouble spot for railroads, as low-cost natural gas is causing coal-fired power plants to be idled.
A slowdown among railroads could play into the hands of Canadian Pacific Railways (CP) - Get Report, which last Fall made an unsuccessful unsolicited bid for CSX (CSX) - Get Report. CP chief executive Hunter Harrison is a vocal advocate of consolidation, saying that North American rail gridlock can only be undone by mergers.
Many industry watchers at the time viewed Kansas City Southern as another potential Canadian Pacific target, though Harrison in October called that railroad "very expensive." But shares of Kansas City Southern are now off more than 15% from their Fall highs and the company's price to earnings ratio has fallen from about 26 times in October to a current 23.2.
Canadian Pacific has less coal exposure than its U.S. counterparts and should be better positioned to continue to expand volumes in the quarters to come. Even if Harrison shies away from Kansas City Southern due to its Mexican exposure, an overall downtick in industry valuations at a time when CP is outperforming could tempt Harrison to look again at a CSX or another deal.
Mergers among the top railroads has been a taboo subject among regulators including the U.S. Surface Transportation Board, which put a temporary moratorium on consolidation back in 1999. But that action that has not been tested since.
Still, Harrison's ill-fated run at CSX is a reminder that animal spirits haven't been totally quashed, and his arguments that gridlock in urban areas where new rail construction is difficult can only be solved via consolidation could appeal to regulators who insist that deals would have to "enhance" and not "merely preserve" competition.
Analysts say if one deal is consummated it would likely lead to a cascade of combinations, with CP, Canadian National Railway Co., Union Pacific (UNP) - Get Report and Warren Buffett's BNSF Railway Co. among the possible buyers and Kansas City Southern, CSX and Norfolk Southern (NSC) - Get Report possible targets. A decline in valuations could be just the spark to get executives talking. Can't you hear the whistle blowing?