(The following column by Dave Schneider appeared at Logistics.com on February 28.)
Questions keep coming about rates. What are rates going to do? There seems to be a consensus that the rates are going to continue to be soft, as we enter into the pre-election recession.
The question to ask; who has the pricing power, the shipper or the carrier?
And the second question to ask; what mode?
I’m in a railroad frame of mind today. The railroad industry is chewing a 11% year on year revenue growth story. In the big 4 (CSX, BNSF, NS and UP) the lowest operating margin is 20%, the highest is 27%. (Go North of the border and look at the CN with a whopping 36% operating margin). The roads are investing in capital intensive projects to increase track capacity, create more direct routing and adding locomotives and freight cars to haul the additional demand, and they can not keep up.
And demand is up. While the retail, auto and home building sectors are weak, there is an increased demand for traditional bulk shipments such as steel, coal, wheat and liquids. The railroads are hauling record levels of commodities. And that demand is placing pressure on the rail network capacity. More demand than supply.
OK, so bulk demand is up. That should mean that the railroads have pricing power. But the consumer is weak? Isn’t that going to place pressure on rates? I don’t think so.
Consumer demand may soften, but that soft demand is going to impact other modes of transport, specifically the LTL and parcel markets. Import demands should remain steady, and the ‘integrated” truckload carriers are placing more “long haul” trailer loads onto the rails. Both Schneider and JB Hunt reported double digit growth in inter-modal shipments as customer moved not only long haul shipments to the rails, but medium haul lanes. Schneider announced that it is moving more volume over to BNSF and CSX. Both BN and CSX have partnered to improve the “sharing” of lines, with new service from the west coast direct into Atlanta, and faster service through Chicago to New York. Both Schneider and Hunt announced that they are adding more containers to the fleets.
OK, so domestic inter-modal demand is going up, and the main inter-modal trucking companies are adding capacity to absorb the land delivery. Even with new deals, the railroads gained pricing power. How? In the past the railroads provided the trailers, not any more. They are just providing the movement and the yard handling of the container, the cost of the container and the road transport is borne by the truckers. Shippers are moving this way because of the cost advantage, and the service reliability. Yes, service reliability. Both BNSF and CSX are working hard to improve reliability and visibility of the containers.
So for the railroads, I would not expect reductions in rates. In fact, they will gain on the increased inter-modal as more freight moves from over the road truckload to on the rail car.
Another thought on the rails. In an investor conference this month the CFO of The Greenbrier Company (the 2nd largest rail car maker in the US) indicated that they had a huge backlog. Greenbrier makes double stack cars (as does Trinity Industries), hoppers and tank cars. Part of the huge backlog is a very large, multi year order from General Electric Capital for hopper and tank cars. GE Capital will lease the cars to power companies and chemical companies needing to increase capacity for the movement of coal and ethanol. The railroads do not need to invest in the cars, just the locomotives and the tracks to haul the additional volume. GE Capital must be expecting higher demand if they are placing long term orders for thousands of rail hopper and tank cars.
Now look at who is investing in the rails. Do some homework, but one big name is a guy from Omaha who knows a good investment. If Mr. Buffett is investing, he must think that the business is growing and that the company, if not the industry, has pricing power.
The bottom line on the rail and inter-modal modes, the railroads hold the pricing power, and will for some time. As long as there is demand for grain, steel, coal, ethanol and other bulk commodities, and the economic cost pressures remain on the trucks, the railroads have plenty of demand to price into.
Let’s hear feedback from the railroad shippers. What are you seeing as you look into the contracting season? Are you rail shippers feeling a bite of rate increase?
(A disclaimer note: I hold shares of BNI, GBX, GE, and BRK.)