(Reuters circulated the following by Nick Carey on April 20.)
DETROIT — Despite a wobbly economy and sliding freight volumes, U.S. railroads have chugged along in recent quarters thanks to strong pricing — and barring a deep and prolonged recession they show no sign of stopping.
“I think the railroads’ pricing power story is going to last for several more years at least,” said Keith Schoonmaker, an analyst at Morningstar.
Higher fuel costs are also seen likely to help the railroads take market share from trucking companies — it takes three times as much fuel to move freight by truck than by train — and improved productivity is expected to help bottom lines.
On April 15, Jacksonville, Florida-based CSX Corp was the first of the four major U.S. railroads to post first-quarter results, reporting a 46 percent rise in net profit that came comfortably above Wall Street forecasts — despite a 2 percent drop in freight volumes.
“Strong fundamentals and pricing from CSX may bode well for other rails this earnings season,” Morgan Stanley analyst William Greene wrote in a note for clients. “While higher fuel prices will weigh on earnings near-term, we will be watching … for any signs of greater shifts from truck to rail.”
Leading U.S. railroad Union Pacific Corp. and smaller rival Norfolk Southern Corp. report results next week. Burlington Northern Santa Fe Corp (BNSF) — in which Warren Buffett’s Berkshire Hathaway Inc (BRKa.N: Quote, Profile, Research) holds an 18 percent stake — will report the following week.
Railroad analyst Tony Hatch of ABH Consulting said some specific issues separate CSX from some of the other railroads.
Like Union Pacific, CSX is still making major strides in improving productivity — BNSF and Norfolk Southern began the same process earlier — and like Norfolk Southern it also benefits from profitable U.S. coal exports on the east coast.
CSX is also fighting an acrimonious proxy battle with The Children’s Investment Fund (TCI), a shareholder that Hatch said “provides additional pressure to produce good results.”
“That said, what the other railroads and CSX have in common is a diverse product mix and distinct fuel economies versus trucks,” he added. “The only long-term risk is what happens with the U.S. economy.”
DEFYING EXPECTATIONS
The U.S. railroads were deregulated in 1980 and spent two decades merging and pulling up tracks in an industry seemingly on the wane. But that has changed in the past few years.
Soaring imports of consumer goods from developing nations like China, plus a spike in demand for commodities such as coal and ethanol have seen railroads scramble to put in new tracks to handle the extra traffic. That allowed the railroads to significantly raise prices for the first time in years.
“This pricing power comes after a couple of decades in which rail freight prices declined in real terms,” Morningstar’s Schoonmaker said. “Plus, there are still some customers contracts that have yet to be re-priced.”
Some analysts have dubbed this run of good fortune the “rail renaissance.” And as the U.S. economy has moved toward a possible recession, the railroads have defied expectations with rising profits despite hauling less freight.
Compare this with the U.S. trucking sector. A combination of the U.S. housing crisis, lackluster retail sales and weak auto sales have been hurting truckers since the third quarter of 2006. Lower freight volumes have hit prices as more companies chase less business.
On April 16, trucking and logistics company Con-way Inc. — regarded as one of the better U.S. less-than- truckload operators (LTL) — posted a lower profit and described the current business climate as “lackluster at best.”
LTL operators consolidate small loads into a single truck.
But though they too face lower freight volumes, the railroads are seen maintaining prices unless there is a serious downturn — especially if high fuel prices continue to push business their way from the truckers.
“The biggest risk to the railroads’ pricing power is a deep, full-blown recession — but that would hurt no matter what industry you’re in,” said Lee Klaskow, an analyst at Longbow Research. “But we’re not expecting a deep recession.”
Longbow predicts a shallow recession that would last about three quarters, he added.
Andrew Meister, a portfolio manager at Thrivent Investment Management, said he suspects the rails are in a long-term cycle of expansion where prices will remain strong no matter what.
“On the face of it, it doesn’t make sense that freight volumes are going down but prices are going up as that contradicts the theory of supply and demand,” Meister said. “But I’m beginning to think the railroads experience 20-year cycles and that regardless of the economy right now, customers will end up paying more even if they move less freight.”
“I think Warren Buffett knows that and that’s why he’s invested a lot of money in the railroads,” he added.