Railroads Linked in Class Action - Analyst Blog

By Zacks Equity Research,

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The District of Columbia (DC) court has granted class action status to a lawsuit charging major North American railroads for exercising pricing discretionary on fuel surcharges. A class action lawsuit would now imply that the railroads have to defend themselves from collective charges brought by a group of shippers under Federal Rules of Civil Procedure Rule 23 and 28 U.S.C.A. § 1332(d).

The U.S. district judge, Paul Friedman of the DC court, brought forward the case of eight shipping companies that accused major railroads of imposing a series of price increases between 2003 and 2008. 

These railroads include Union Pacific Corporation ( UNP ), Norfolk Southern Corp. ( NSC ), CSX Corporation ( CSX ) and Burlington Northern Santa Fe. These Class I railroads dictate more than 90% of the freight revenues in the industry. Shippers have been constantly targeting these railroads, accusing them of monopolistic practices.  

The pricing practice of the U.S. freight railroads is a major cause of friction with captive shippers which move their products through rail and do not have effective alternatives.  Since 1980, railroads have been enjoying significant pricing power based on The Staggers Rail Act that substituted the long existing Interstate Commerce Act of 1887. The Staggers Rail Act provided greater flexibility in respect of freight pricing with less regulatory constraints, more freedom in collective ratemaking as well as entry and exit of companies from the industry.

The Act allowed the rail industry to recover from its most unprofitable period since the Great Depression, when these railroads where exposed to stringent pricing regulation by Interstate Commerce Commission. Additionally, the rise in automobile and truck freight market largely dethroned the rail business. Hence, Staggers Act remains an important milestone in the history of rail industry for its recovery from a dark period.

However, over the past several years shippers are continuously struggling to put railroads under review for indulging in unfair pricing practices. This has not only affected the shippers through increased shipping costs, but is also hurting consumers. Customers have accused railroads of extracting more fuel surcharges from them as well as indirectly charging for other costs, increasing shipping cost by almost 100% since 2004, while shipping cost from other modes have only gone up 20%. 

Studies show that rail pricing has dramatically shot up since 2004 and continues to increase, with average rise of approximately 4 to 6% per year. On the other hand, other modes of transportation like trucking and air freight have only risen by approximately 1-2%. Studies have also revealed that all major freight railroads' fuel surcharges exceeded by approximately $6.4 billion from the actual cost between 2003 and 2007.

Railroads lashed back arguing that despite the ongoing hikes, prices remain below the 1980 levels considering the economical factors. Further, they protest that fuel surcharges which are subject to adjustments depending on fuel price changes have not been successful in tapping rising fuel prices.

We believe that the issues between the railroads and shippers remain a long-standing battle. This will continue to be so as long as matters regarding price fixing by the railroads continue to be out of the realm of the U.S. antitrust laws.

Per the latest studies by Surface Transportation Board (STB), approximately 35% of the annual freight rail is captive to a single railroad, allowing its monopoly pricing practices. The unfair pricing power exhibited by the U.S. railroads has summoned congressional intervention for exercising stringent federal regulations on the railroads. Congress has discussed railroad price regulation but has not passed any new rule so far.

In February 2012, shippers forwarded a joint letter to Congress appealing to support Amendment 1591 to the Surface Transportation Bill to abolish freight rail industry exemptions from the U.S. antitrust laws. The amendment, proposed by Senator Herb Kohl, would create healthier competition among freight rail shippers and stop unfair pricing polices.

Any change brought forward by Congress or the STB would mean good things for the larger market but could mean a serious threat to railroads. Especially when economic uncertainty is generating poor volumes and pricing has become a dominant factor for the recovery of the industry.

We have our long-term Neutral recommendation on Union Pacific, Norfolk Southern and CSX Corporation. For the short-term (1-3 months) these stocks hold a Zacks #3 Rank (Hold).

CSX CORP (CSX): Free Stock Analysis Report
NORFOLK SOUTHRN (NSC): Free Stock Analysis Report
UNION PAC CORP (UNP): Free Stock Analysis Report
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Zacks Investment Research

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article appears in: Investing , Business , Stocks
Referenced Stocks: CSX , NSC , STB , UNP

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