Investopedia: Are The Rails Starting To Spin Their Wheels?

Economies don't turn on a dime, so "more of the same" is usually the order of the day. The uncertainty that really become apparent early in the summer is still the dominant theme of the U.S. economy. Given that demand for railroad carriage is a derivative of economic activity, it is not so surprising to see that the trend in rail car traffic has likewise become uncertain. Investors should note, though, that while growth is no longer unequivocal, there are still positive trends at work. 

August Rail Numbers  
In the latest Rail Time Indicators from the Association of American Railroads, August carload traffic in the United States fell 0.3% from the year-ago level and remained flat with the prior month. Intermodal traffic climbed 0.4% and 0.3% for the same time periods. Of the 20 reporting categories of traffic, 12 showed gains in the month of August - consistent with July, but down from 16 in the year-ago period.

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Investopedia: A Primer On The Railroad Sector

Maybe it seems quaint that an industry most associated with robber barons, the 19th century and the taming of the West even survives today, but railroads are still very much a significant part of the North American economic infrastructure. As major components of the transportation sector, railroad companies and their stocks are certainly worth the time and trouble to investigate further as their cyclical nature suggests that there will always be opportunities again in the future to buy (or sell) these stocks.

What the Railroads Do
To a certain extent, railroad companies operate a pretty straightforward and obvious business – they charge companies for carrying cargo over their network of rails and railcars. In practice, it is a bit more complicated than that.

Major railroads in North America basically operate as duopolies – Union Pacific (NYSE:UNP) and Berkshire Hathaway's (NYSE:BRK.A) Burlington Northern Santa Fe run routes throughout the Western U.S., Norfolk Southern (NYSE:NSC) and CSX (NYSE:CSX) control the East, and Canadian Pacific (NYSE:CP) and Canadian National (NYSE:CNI) operate throughout Canada. Again, though, the details are a little more complicated.

Within the rail industry, railroads are frequently broken up by category – Class I, Class II and Class III railroads. The distinctions between classes are a product of the railroad's revenue, with Class I being the largest and Class III being the smallest. In actual practice, though, these categories have questionable value – Kansas City Southern (NYSE:KSU) is technically a Class 1 railroad, but is much smaller than even the smallest of the "Big Six". Nevertheless, it is worth noting that there is profit opportunity not only in running large continental networks, but also operating smaller short-line railroads that connect industries to supply sources (like a power plant and coal mine) or connect companies and small towns to larger railroad lines. (Look at the big picture when choosing a company - what you see may really be a stage in its industry's growth. (For more insight see Great Company Or Growing Industry?)

To read the primer, please click here:
http://www.investopedia.com/articles/stocks/11/primer-on-railroad-sector.asp

CSX Running Hot On The Rails

If the first earnings report from the railroad sector is any indicator, there is going to be plenty of fundamental support to back up the hot stock performance of recent times. CSX (NYSE: CSX) does not have the best historical reputation, but if this company is doing well it stands to reason that this is going to be a fine quarter for this part of the transportation sector. 

The Quarter That Was
CSX reported that overall revenue rose 16% in the third quarter. Merchandise sales rose 15% (that is basically non-coal rail traffic), while coal revenue was up 23%. Carload volume increased nearly 10% this quarter (not bad), while yields were up about 6% (better!). 

Interestingly, intermodal revenue was up only 6% this quarter - interesting, as that is weaker than recent rail reports have indicated for the intermodal industry. Then again, with Western Europe in something close to hibernation, perhaps CSX's East Coast exposure keeps a lid on that intermodal performance. If that is true, then Union Pacific (NYSE:UNP), Berkshire Hathaway's (NYSE:BRK.A) Burlington Northern, and the two Canadian operators (Canadian Pacific (NYSE:CP) and Canadian National (NYSE:CNI)) could be expected to do quite a bit better on that line. 


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CSX's Unsurprising Surprise

For a few months now, I have had a standard response to the skeptics of the economic recovery, and it goes something like this. "If the recovery is not real, and if the recovery is stalling out, why are the railroad shipments still strong?" That point was driven home again with strong results from Eastern railroad operator CSX (NYSE:CSX).  

The Quarter That Was 
By virtually any metric, CSX had a very strong quarter. Revenue was up 22% over last year, as both volume and pricing were strong. Volume (as measured by carloads) climbed about 13% from last year, while pricing (revenue per carload) rose about 8% over the same time period. Revenue of $2.7 billion exceeded the average estimate, which makes the source of the surprise pretty apparent - since the company reports intra-quarter volumes frequently, it was the pricing that was the strongest surprise.

CSX's results gained strength on down through the income statement. Reported earnings jumped 36%, while profits from continuing operations jumped 47%. The operating ratio also improved; the reported number of 71.2%. Assuming that is accurate, that is not only a 340 basis point improvement from last year, but I believe it is the best level the company has posted since the 1999 split-up of Conrail with Norfolk Southern (NYSE:NSC). That is an impressive sign of improvement in a metric where CSX has long been a laggard. (For more, see Ratio Analysis Tutorial.) 


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