For Immediate Release
Chicago, IL - August 26, 2015 - Today, Zacks Equity Research
discusses the Railroads, part 2, including
Canadian National Railway Co.
Kansas City Southern
Union Pacific Corp.
Norfolk Southern Corp.
Canadian Pacific Railway Ltd.
Industry: Railroads, part 2
A rising population directly translates into an increase in freight
demand. According to the U.S. Department of Transportation, each
American requires the movement of approximately 40 tons of freight
per year across the freight network. Thus, we can see the growing
importance of the freight network in our daily lives.
Meanwhile, the railroad industry is set to gain from an improvement
in the U.S. economy characterized by increased investments,
implementation of safety standards and an improved pricing
environment. Moreover, higher than expected second-quarter earnings
performance by most railroad operators is expected to continue in
the coming quarters. In addition, improving operating ratios driven
by better cost-control measures will continue to propel growth for
the railroads moving ahead.
Below, we discuss key factors that investors should consider before
investing in the railroad sector:
Crude by Rail: Emerging Market
The transportation of oil happens to be a profitable venture for
railroads. However, the development of pipelines has made the
transportation of oil from the basins more convenient for most oil
Meanwhile, there is no alternative to pipelines and railroads for
the transportation of crude oil from key fields like the Bakken
Shale Formation in North Dakota and Montana, the Eagle Ford Shale,
Barnett Shale and Permian Basin in Texas, and the Gulf of Mexico
and Alberta oil sands,. Moreover, these oil reserves lack proper
pipeline support, which makes railroads an indispensable mode of
transportation. Pipeline developments also could not keep pace with
the increase in oil supply, making railroad even more essential.
We also believe that the present slump in
will have a moderate impact on railroad profitability as most oil
producing companies barely slash production volumes in such
scenarios. As per the U.S. Energy Information Administration's
(EIA) latest Short-Term Energy Outlook, crude oil production will
reach an estimated 9.36 million barrels per day in 2015, up from
8.71 million recorded in 2014. Hence, the raised guidance indicates
better revenue growth for the railroad industry which is on track
to achieve infrastructural growth.
As a result, inadequate pipeline developments have given rise to
higher penetration of railroad transportation for crude oil
shipping in Canada. Moreover, places like North Dakota, where crude
oil production has increased manifold times over the last few
years, lack proper pipeline network for oil transportation. Hence,
the demand for railroad transport is benefiting from this.
According to the North Dakota Pipeline Authority, railroads
transported over 60% of the state's crude oil production, which
contains the vast majority of new rail crude oil originations.
In addition, rail transportation is reliable as it offers safety
and less spill rate as compared to pipelines. Moreover, rail
companies are continuously investing in upgrades to improve safety
standards. Moreover, implementation of new rules set by Federal
regulators will prevent oil spill accidents and minimize losses.
As per the Association of American Railroads (AAR), the country's
key railroad operators are expected to invest nearly $29 billion in
fiscal 2015. Moreover, such high investments in the U.S. railroad
industry will open up employment opportunity for nearly 15,000
Railroads stretch over roughly 140,000 miles of track which require
constant monitoring and maintenance. Over the last 30 years, the
U.S. railroad industry has spent nearly $575 billion. Investments
as huge as these have helped enhance the infrastructure of railway
which is needed to compete effectively with other modes of
transportation like truck, barges and cargo airlines. Also, a
better rail network has facilitated timely and safe delivery of
goods and products to different parts of the U.S. This has
also helped to bring down accident rates considerably.
In order to provide better infrastructural support as well as high
safety in Western Canada, the Canadian National Railway Co. (
) plans to invest C$500 million in railways networks. Moreover,
Kansas City Southern (
) will expend nearly $34.6 million to improve its cross border
safety standards and expand capacity. Moreover, Kansas City
Southern plans to spend $650-$670 million in 2015. Also, Union
Pacific Corp. (
) plans an investment worth $23 million in New Mexico's
transportation infrastructure and $15 million for the rail line
connecting the Missouri/Iowa border and Trenton.
However, this sector, characterized by huge capital influx, has
been primarily drawing funds through private financing. On the
contrary, cutting down on investments will soften the growth
prospects for the overall industry.
According to the Department of Transportation (DOT), the demand for
rail freight transportation will increase approximately 88% by
2035. As a result, Class I carriers will have to ramp up their
investments to meet growing demand.
DOT also believes that almost 90% of the railway capacity needs to
be upgraded to meet the expected rise in demand level by 2035.
Hence, it is important for railroad companies to balance profit
levels while investing in infrastructural development projects.
Currently, the U.S. railroad industry covers less than 50% of the
total freight market in America, indicating a huge opportunity for
market share expansion. This opportunity can only be exploited
through the improvement of railroad infrastructure that caters to
the varied requirements of shippers.
Improving Safety Measures:
According to the latest rules set by federal regulators, the aging
and unsafe tank cars should be replaced within three years to
enhance safety. The newer version of the tank cars will be equipped
with thicker shells and higher safety shields, thereby providing
enhanced fire protection. In recent times, rail safety has become a
major concern. The National Transportation Safety Board (NSTB) --
an independent U.S. federal government agency -- had recommended
the use of ceramic thermal blankets to promote safety standards
amid multiple derailments of crude oil trains over the last couple
Also, in Apr 2015, the transportation department issued emergency
directives such as restricting the speed limit to 40 miles an hour
in urban areas for trains transporting hazardous materials.
According to the instruction, railroad companies will have to
furnish detailed shipment-related information within 90 minutes of
a derailment, if one occurs. The issue of rail safety has also made
the Canadian government take notice. The Canadian government has
issued an emergency directive, which is operative till Aug 17, and
requires trains to limit speeds at under 40 miles/hour in urban
areas as opposed to the previous bar of 80 kilometers/hour.
Thus, we believe that implementation of stringent speed-limit rules
will help avoid accidents and also narrow losses arising from
Duopolistic Market Structures:
The freight market is mainly dominated by railroad companies that
practice discretionary pricing methods. Hence, unavailability of
any proper pricing standard by the controlling body allows rail
companies to generate substantial profits by manipulating prices in
the duopolistic market.
This is evident from the geographic distribution of markets between
major railroads. Union Pacific and Burlington Northern Santa Fe
control the western part of the U.S., while Norfolk Southern Corp.
) and others manage the eastern part. On the other hand, Canadian
Pacific Railway Ltd. (
) and Canadian National control inter-country rail shipment between
the U.S. and Canada.
Discretionary Pricing Power:
After the adoption of the Staggers Rail Act in 1980, freight
railroad service providers have been enjoying considerable pricing
power. The main objective behind the enforcement of the act was to
allow rail operators to raise prices on captive shippers like
electric utilities, chemical and agricultural companies in order to
boost profits. Thus, the Staggers Rail Act has been helping
railroad companies in maintaining double-digit profit margin by
means of increasing freight rates by nearly 5% per annum, on an
Check out our latest
Railroad Industry Outlook here
for more on the current state of affairs in this market from an
earnings perspective, and how the trend is looking for this
important sector of the economy now.
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