In the third quarter of 2012, we highlighted weak rail traffic as being driven by weaker coal shipments, and the trend continued throughout the fourth quarter. According to the Association of American Railroads (AAR), coal shipments for the week ending on December 22 fell 11.1% year-over-year. Given the wealth of railroads that were heavily leveraged to coal, including Norfolk Southern (NSC), CSX (CSX), and Union Pacific (UNP), it would be natural to assume the entire segment is ripe for decline.
Yet, that doesn't appear to be the case. The AAR also reported that total rail traffic for that same week increased 0.9% compared to the previous year and intermodal volume was up 10.2% compared to the previous period a year ago. Consistent with the shale oil revolution, petroleum shipments jumped 71.5%, while housing also drove strength, as crushed stone, gravel, and sand jumped 29.5% and lumber and wood products advanced 27.3%. As long as economic expansion continues, rails will benefit as a lower cost and relatively efficient means of transportation.
With intermodal transportation increasing significantly, logistics firms could also benefit. Transportation services companies such as J.B. Hunt (JBHT) and CH Robinson (CHRW) are two that come to mind. Intermodal revenues at J.B. Hunt have grown at a double-digit pace throughout 2012, and we wouldn't be surprised if the company reported similar revenue growth for the fourth quarter. CH Robinson is less leveraged to intermodal transportation, but we think that could change as intermodal becomes more important to the overall mix of the transportation industry.
Another potential catalyst for rail demand could be increased new vehicle sales. We'll hear from the likes of Ford (F), GM (GM), and Toyota (TM) soon, and we expect the numbers to be strong. The SAAR was 15.2 million units in November, and we're expecting strong sales throughout 2013 (now that the fiscal cliff has been averted). As OEMs invest in Mexican plants, Kansas City Southern (KSU) will likely benefit due to its extensive rail network in the country.
Image Source: Kansas City Southern
Overall, we believe the railroads are fairly valued at current levels. However, we continue to like the long-term industry trends, especially since there simply aren't enough pipelines available in the US to transport the tremendous amount of oil that will be produced over the next several years. Whether or not coal remains weak, overall transportation should continue to grow as long as economic expansion remains intact. We wouldn't hesitate to add a railroad to the portfolio of our Best Ideas Newsletter at an attractive price (below the low end of our fair value range on improving technicals).
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.Some of the firms mentioned in this article may be included in our actively managed portfolios.