(The following story by Christopher Dinsmore appeared on The Virginian-Pilot website on January 30.)
NORFOLK, Va. — Something remarkable happened last year in the railroad industry.
The mature industry’s growth rates have long followed the nation’s industrial production. As the nation’s factories produced, traffic grew. But that rubric appears shifted last year.
Two of the nation’s four largest railroads – No. 4 Norfolk Southern Corp. and No. 2 Burlington Northern Santa Fe Corp. – reported double-digit revenue growth, thanks to a combination of rising traffic and increased shipping rates.
Meeting with analysts Wednesday in New York, Norfolk Southern reported that its 2004 revenue surged 13 percent to $7.3 billion. Only Burlington Northern grew faster, with 16 percent revenue growth last year.
Norfolk Southern “showed me revenue growth numbers that in 20 years as a rail analyst I thought I was never going to see,” said Anthony B. Hatch, an independent analyst in New York.
A renaissance for the rail industry is under way, and the railroads that have the capacity are taking advantage of it while others are choking.
The nation’s railroads are shifting from being carriers of industrial goods to carriers of a mix of industrial and consumer products. The shift is being driven by the globalization of manufacturing, a rethinking of supply chains and growing constraints on the nation’s highways and trucking industry.
Among the biggest railroads, Norfolk Southern and Burlington Northern were well positioned to accommodate the demand. No. 1 Union Pacific Corp. and No. 3 CSX Corp. both struggled and didn’t experience the same growth.
Hatch and other analysts liken the difference to the haves and have-nots. Norfolk Southern and Burlington Northern clearly are haves. Suffering from congestion, accidents and bad weather, Union Pacific is a have-not; CSX is somewhere in between, but improving.
Investors are taking notice as well. Norfolk Southern’s stock climbed about 50 percent in the past year. It recently settled somewhat, closing Friday at $34.06, reflecting some wariness of rising costs, particularly for fuel.
There’s also worry that recent rail accidents, including the deadly Norfolk Southern train wreck Jan. 6 in Graniteville, S.C., could lead to increased scrutiny and perhaps renewed regulation of the railroad industry for safety issues.
“Clearly part of our growth is attributable to the strong U.S. industrial economy,” said Charles W. “Wick” Moorman IV, Norfolk Southern’s president. “However, we believe that shifting international trade patterns in terms of both consumer products imports and global energy sourcing, along with highway transportation issues, also are key structural drivers of that growth.”
Norfolk Southern’s cargo volumes last year, as measured by carloads, surged 8.8 percent, about double the anticipated rate for U.S. gross domestic product in 2004.
“The company is clearly benefitting from being the best East Coast rail operator, the supply/demand dynamic within the tight freight transportation industry, and strong demand for most of its lines of business,” said John Larkin, rail analyst at Legg Mason, a Baltimore-based brokerage house, in a research report written Wednesday.
The railroad’s 2004 growth came in every business segment except automotive, which slipped 1.6 percent. Metals shipments rose 10 percent. Coal shipments increased 4.7 percent, driven by a 35 percent gain in its profitable shipments of exports haul.
But the big gainer was intermodal traffic, which jumped 17.2 percent. Intermodal involves the shipment of truck trailers and international shipping containers, which often carry consumer products.
“Norfolk Southern was always a good operating company, but what’s good to see is they’ve become an intermodal player,” Hatch said.
Intermodal shipments have long held the promise of becoming a hot growth sector for railroads that can handle the business efficiently and competitively. Railroads compete directly with the trucking industry for such traffic.
Truckers can be faster and more time sensitive, but they are more expensive the longer the haul gets. The trucking industry is facing growing highway congestion, government spending constraints on further highway building and a driver shortage that is pushing up prices and slowing its responsiveness.
As a result, shippers are rethinking their supply chains and turning more and more to railroads to haul their freight. Railroads are also safer and more environmentally friendly than trucking.
“Railroads are not going to displace trucks; they’re working with trucks,” Hatch said.
At the same time, imports of consumer goods from Asia have boomed as manufacturers chased cheaper labor in China and elsewhere. Congested West Coast ports prompted container shipping lines to begin offering direct services from Asia to the East Coast.
With a rail franchise that reaches every major East Coast port, Norfolk Southern was able to take better advantage of the manufacturing and shipping shifts than rival CSX, which also saw intermodal growth – but not as strong as Norfolk Southern’s.
“We have a total supply chain capacity issue heading at us in the U.S. right now, with the truckers sort of at their maximum capacity and the railroads sort of at or near the maximum of what they can handle,” said Jason Seidl, an analyst with Avondale Partners, a Nashville-based investment bank, in an interview on Bloomberg News. “This could be a good thing for the railroad industry because it does leverage their pricing power.”
The railroads leveraged that power last year, explaining why the top four increased revenues faster than their volume grew. With their service in demand, they were able to raise prices.
Norfolk Southern boosted its revenue per carload in every business segment. Coal revenue per car grew 10 percent; intermodal revenue per unit grew 5.8 percent; and merchandise revenue per car, including its core industrial goods shipments, grew 4.7 percent.
The increases came from a mix of rate increases and fuel surcharges to make up for the soaring cost of the diesel that powers the locomotives.
Despite rising fuel costs and a program to hire more train crews that steadily boosted employment all year, Norfolk Southern’s expenses grew more slowly than its revenue. While revenue rose 13 percent, operating expenses increased 3.8 percent.
As a result its operating ratio – its operating expenses expressed as a percent of its revenue – fell to 76.7 in 2004 from 81.9 the previous year, excluding one-time charges.
It’s the lowest operating ratio of the big four railroads. Burlington Northern’s comparable ratio was 80.0, CSX’s 87.6 and Union Pacific’s 87.4.
“We achieved our goal of seven and seven,” said David R. Goode, Norfolk Southern’s chairman and chief executive officer. “That is annual revenues starting with a seven and an operating ratio starting with a seven.”
Norfolk Southern and its analysts credited the company’s 3-year-old Thoroughbred Operating Plan for enabling it to handle more traffic without significantly boosting costs.
“The TOP plan is a major help,” Hatch said. “Those who learned to manage their system, when the tidal wave of volume came, were able to handle it.”
Norfolk Southern had another leg up as well. From its formation in 1982 until the takeover of Conrail, Norfolk Southern managed itself conservatively, keeping debts low and focusing on its core railroad business.
“Their system is in good, even very good condition because they’ve been able to maintain it,” Hatch said. “Plus, Norfolk Southern has invested strategically.”
In 20 years, the company has gone from hauling coal and industrial materials to carrying those things plus consumer goods in trucks and containers to the nation’s retail distribution network.
“They’ve seen the future and adapted to it quickly,” Hatch said.