Back on track: Railroads are acquiring competitive edge in shipping
By Angela Greiling Keane
Bloomberg News
Nobody likes the rising price of oil better than U.S. railroads.
Union Pacific trains in a rail yard in Salt Lake City. Union Pacific is largest U.S. rail company. (Tom Smart, Deseret Morning News)
Tom Smart, Deseret Morning News
Union Pacific trains in a rail yard in Salt Lake City. Union Pacific is largest U.S. rail company.
As the cost of crude soars, rail is gaining a competitive edge after losing ground to trucks for half a century. Even as automotive plant closings and reduced U.S. housing construction have contributed to a 4.4 percent drop in train shipments this year, investors including Warren Buffett and Carl Icahn are flocking to railroad shares, betting that higher oil prices and surging Asian imports along with congested highways will boost long-term demand.
"Earnings and stocks could quadruple within five years, which makes the stocks a bargain today," said Snehal Amin, a partner in London-based TCI Fund Management LLP.
Rail shipping volumes grew to a record in 2006, boosting shares and earnings at the four biggest operators, Union Pacific Corp., Burlington Northern Santa Fe Corp., CSX Corp. and Norfolk Southern Corp. The Standard & Poor's 500 Rail Index has tripled since March 2003.
As the price of oil climbed 37 percent in five months from Jan. 18, shares of Union Pacific, based in Omaha, Neb., the biggest U.S. railroad company, gained 24 percent. Shares of CSX, based in Jacksonville, Fla., the third-largest, rose 26 percent.
"Railroads typically are about three times more fuel-efficient than trucks," said Jason Seidl, a New York-based analyst at Credit Suisse. Higher fuel prices "will drive up the differential."
Rail's rise and fall
Credited with having "built America," railroads were once key to U.S. westward expansion and economic growth. The first transcontinental railroad was completed with federal backing in 1869, linking the Western and Eastern halves of the country with a mechanized transportation system for the first time.
Almost a century later, railroads started losing out to trucks after the interstate highway system was begun in 1956. Trucking gained further when interstate speed limits were raised in the late 1980s.
Union Pacific's intermodal terminal in Salt Lake City. Rail shipping volumes grew to a record in 2006, boosting shares and earnings. (Laura Seitz, Deseret Morning News)
Laura Seitz, Deseret Morning News
Union Pacific's intermodal terminal in Salt Lake City. Rail shipping volumes grew to a record in 2006, boosting shares and earnings.
Trucks carried 69 percent of domestic U.S. freight in 2005, up three percentage points from 1994, according to the American Trucking Associations, based in Alexandria, Va. Railroads moved 13 percent, down two points in the same period, while planes, pipelines and waterborne vessels accounted for the rest.
Higher oil prices suggest the trend may be reversed.
"We expect the rails, after 40 years of ceding volumes to the highway, to take back market share over the next 10 years," wrote Edward Wolfe, a New York-based analyst at Bear Stearns & Co., in a May 7 report to investors.
While trucks offer a cost advantage on most short hauls and can reach places not accessible by rail, they consume about four times as much fuel to move a shipment as a train does, according to U.S. Energy Department data. Shipping rates are about five times higher for trucks than trains, said Amin of TCI, which is the fifth-largest shareholder of CSX, according to Bloomberg data.
The price of oil has jumped about 80 percent in the past three years. The Energy Department has predicted the commodity may rise as high as $100 a barrel by 2030.
"There's no question that trucking is less competitive now than it was three or four years ago," Amin said. "Unless oil prices are going to fall, and fall substantially, they're not going to be more competitive."
Outperforming trucks
Rail shares rose more than twice as fast as the Standard & Poor's 500 Index in the five years to May 31, while trucking stocks lagged behind the S&P 400 Midcap Index by 61 percent.
Congestion and labor costs are also hurting the competitiveness of trucks.
The American Association of State Highway and Transportation Officials cited highway congestion as a main reason why logistics costs rose to 9.5 percent of the U.S. gross domestic product in 2005, from 8.6 percent in 2003 — the biggest increase in 30 years, according to the Council of Logistics Management.
"The gap in service levels and traffic times is only moving in favor of the rails," said Satish Jindel, president of Pittsburgh-based SJ Consulting.
While truck drivers earn less on average than train operators, railroads use less labor per shipment than trucks, according to TCI.
Railroads are getting a double benefit from the rising price of oil, because it's also driving up domestic demand for coal and ethanol as energy sources. Both commodities are carried mainly by rail, as are corn and fertilizer, used to produce ethanol.
Union Pacific credited ethanol-related shipping for a 24 percent surge in first-quarter profit this year. The railroad's agricultural shipping revenue grew by 8 percent in the quarter as farmers planted the most corn since World War II, and chemical shipping revenue, including finished ethanol, rose 9 percent, Chief Executive Officer James Young said in April.
Surging imports from Asia are another booster for rail. The goods arrive on container ships to the U.S. West Coast and move inland by rail and truck. U.S. imports from China have more than quadrupled in the past decade.
Helping trains grab more West Coast port traffic is the increased number of rail lines that reach port terminals, said Paul Bingham, a Washington-based economist at Global Insight Inc. At the same time, congestion is increasing the time it takes for trucks to enter and exit ports.
"The railroads have potential to capture more share," Bingham said.
Activist shareholders
Railroads also appear to be responding to pressure from new shareholders to improve returns.
In addition to CSX, TCI bought stakes in Union Pacific and Norfolk Southern, the fourth-largest U.S. railroad. Amin told rail executives and others who attended a transportation conference in May in New York that CSX and other railroads should increase their debt and raise prices as means to return more cash to shareholders.
Since Amin spoke and met with management, CSX said it will raise prices as much as 7 percent this year, and Norfolk Southern said it may expand a share buyback program it announced in March.
Other new investors include Buffett's Berkshire Hathaway Inc., which disclosed an 11 percent stake in Burlington Northern in April, making it the railroad's biggest shareholder. Berkshire was also among the 10 biggest shareholders of both Union Pacific and Norfolk Southern as of March 31, a filing showed.
Billionaire Icahn, who often uses his influence as a large investor to press for changes at companies to boost share prices, bought a $122 million stake in CSX, a May filing showed.
Volume dip
A slowdown in the U.S. economy could still derail the industry's growth. The recent decline in freight is expected to continue through the end of the third quarter, said Global Insight's Bingham.
The volume dip may cut into near-term profits, UBS Securities analyst Rick Paterson wrote in a June 14 report.
Proposals in the U.S. Congress, supported by some railroad customers, may also repeal current antitrust exemptions for rail operators, giving customers more power to negotiate lower prices. Separate legislation in the U.S. House of Representatives would tighten rail safety regulations, adding cost for the industry.
None of it has stopped railroad shares from advancing. On June 14, Union Pacific told investors to expect this quarter's earnings to be lower than analysts have predicted. The stock rose 1.2 percent, and another 1.8 percent the following day.
"The market either didn't notice," Paterson wrote, "or didn't care."
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