U.S. Rail Transport Bids Fair
The U.S. rail industry includes large railroads as well as regional and local-line haul railroads carrying both freight and passengers. The industry derives a vast majority of revenue from providing Class 1 freight services. The major market segments that the industry caters to are Coal, Industrial Goods, Agricultural Goods, Chemicals, Food & Consumer Goods, Intermodal, Transport & Equipment and Passengers.
The rail industry is undergoing a resurgence. Rail is estimated to be three times more fuel efficient than road freight transport and in a climate of high fuel prices and increased awareness of environmental sustainability, the distant future of rail looks good. Over the five years to 2009, industry revenue has increased by an average of 2.5% per year. However, slack economic conditions are expected to see industry revenue contract by 9.2% in 2009.
Strong annual growth over the last five years has been driven by increased demand for freight transport services in all major market segments; however, slowing economic growth in 2008 in the U.S. pulled back the pace of industry expansion. The difficult domestic economic conditions are expected to continue as the liquidity crisis in the financial markets ripples through the economy. Especially hard hit will be the construction and automotive sectors — major customers of the railroad industry.
As the U.S. economy recovers, manufacturing production picks up and consumers begin spending again in 2010, industry revenue will return to steady growth. Rail transport has been increasing its share of the total transport division, and currently represents 14.9% of total revenue, making it the third largest transport sector (by revenue) behind truck and air transport. These gains have been made at the expense of air transport, which with the current high fuel prices has become too expensive for many.
Though the impact of the current recession on this industry will be negative, the long-term outlook for rail transport is positive. Larger railroad companies are expected to expand through acquisitions. Some of the smaller railroads, such as Wisconsin Central and Kansas City Southern, could become targets for larger railroads to acquire.
OPPORTUNITIES
During the recession, Burlington Northern Santa Fe Corp (BNI) has demonstrated significant operating leverage through its ongoing dedication to control costs and improve productivity. BNI has the best commodity mix and is positioned to be the fastest growing U.S. rail company during the next expansion. The actions taken by management to improve its network and lower its costs should expand the company’s margins when volumes begin to come back online.
CSX Corporation (CSX) looks optimistic based on the its earnings power, pricing power, potential improvements in network fluidity, cost controls, probable improvements in safety and fewer distractions. We expect management to continue to successfully hold down its costs with carloads. Management is doing a solid job of cutting costs while planning for the eventual rebound in the industry. Steady pricing, improving volumes, cost savings and a moderating regulatory environment will likely help the company to outperform its peers in the near term.
WEAKNESSES
The slowing economic conditions in the U.S. will cause industry revenue to contract in 2009 as freight volumes fall. Employment in the industry is expected to contract sharply in 2009 as rail companies slash jobs. In the near term, profits are expected to fall as revenue from fuel surcharges shrinks, along with demand reduction.
Difficult domestic economic conditions are expected to continue through 2010 as the liquidity crisis in the financial markets spreads through the economy. The slowing economic conditions, plunging manufacturing production, consumer spending and international trade are likely to take a further toll on the industry.Zacks Investment Research
