3 Railroad Companies Chugging Along For Higher Returns

Includes: CNI, CSX, UNP
by: Fusion Research

The demand for energy resources like coal, crude oil, and forest products is increasing in the U.S. and Canada due to a rebound in the housing market and an increase in natural gas prices. Increased demand for energy resources has led to a rise in the demand for transportation. This has promoted railroad companies in North America to spend more than $50 billion this year on improving and building new tracks for better connectivity. We have analyzed three railroad companies based on their different business segments that are gaining momentum due to an increase in demand for energy resources.

Rail transportation to benefit from regulatory issues

Canadian National Railway's (CNI) petroleum and chemical segment reported 21% year over-year revenue growth in the second quarter of 2013. The growth represents the increase in demand for transporting crude oil by rail. Pipeline projects are facing regulatory issues that have restricted the construction of new pipelines in Canada. Due to insufficient pipeline capacity in the country, and Canadian National being the largest rail network operator in North America, transporting oil through rail is a growing part of its transportation business. It is estimated that Canada will export more than 200,000 barrels of crude oil by rail per day to the U.S., up by 46,000 barrels per day in 2012. Its petroleum and chemical segment is estimated to generate revenue of $1.88 billion this year.

Due to an increase in construction activity in the U.S., there's high demand for building products. Canadian National witnessed 4% growth in the forest product freight segment due to the rise in transportation of wood products. The rise in the number of new houses has shown an upward trend this year after the housing crisis that began seven years ago. Also, the demand for paper and paper products is rising as it has become the most usable and globalized product. The demand for such products is expected to exceed the current sum of 390 million metric tons to reach 453 million metric tons by 2015. Canadian National's forest product segment is expected to generate revenue of $1.38 billion this year, up slightly from $1.33 billion in 2012.

U.S. shale boom to drive rail transportation business

CSX Crop's (CSX) industrial segment for chemical freight posted revenue growth of 11% year-over year in the second quarter of 2013. The growth represents the demand for chemical freight since the current pipeline capacity in the U.S. is insufficient to transport crude oil due to the U.S. shale boom, as the production has increased in oil rich fields such as Bakken and Eagle Ford Shale. Many oil companies are drilling wells in these regions and are using CSX's rail line, which will drive its transportation business. The production of crude oil in the U.S. is expected to reach 7.05 million barrels per day, or mbpd, in 2013 from 6.41 mbpd in 2012. With this, CSX expects its revenue per carload in its industrial segment to rise to $3180 next year from the current $3,080.

Overall coal volumes are gaining momentum as utility companies in the U.S. are using coal due to the increase in natural gas prices. CSX observed high shipments from coal rich basins like Powder River Basin and Illinois Basin, which resulted in an increase in domestic coal volumes by 5% annually in the second quarter. The demand for coal is also expected to rise in the winter due to the increase in household usage. The total consumption of 952 million short tons, or mmst, is expected for this year and 966 mmst in 2014, up from 890 mmst in 2012. CSX's current revenue per carload for coal freight is $2,520, which it expects to reach $2,610 in 2014.

Coal becomes stronger than natural gas

Union Pacific's (UNP) industrial segment reported freight revenue growth of 7% year over year in the second quarter of 2013. The growth represents an increase in shipments of construction products like wood, cement, aggregates, etc. due to recovery in the U.S. housing market. The increase in the number of US housing starts, or the number of new houses beginning construction, and improving job market, will fuel the capacity of people to buy new homes. This will prove beneficial to Union Pacific's industrial segment and the analysts expect its revenue to increase to $367 million in this year from $350 million in 2012.

Union Pacific's energy commodities freight segment reported an increase in its revenue by 12% year over year in the second quarter of 2013. Recovery in the coal business is driving revenue since utility companies are using coal due to the increase in the natural gas prices. The recent hike in natural gas prices of $4-$4.2 per million British thermal unit, or mmbtu, is turning out to be beneficial for the U.S. coal market, which is stronger than natural gas at this level. According to EIA, the total U.S. electricity generation is expected to rise by 0.8% this year and 1% in 2014, which will drive coal consumption. With this, Union Pacific's expects its energy commodities segment revenue to increase to $409 million this year from $392 million in 2012.


The strong energy market and continuing recovery in the U.S. housing market should drive growth of Union Pacific in the long run. The company foresees to generate EPS of UNP);+Rails+are+Not+Coal+Stocks!/8265013.html" rel="nofollow">$11.06 in 2014 up from current EPS of $8.78 due to the improving housing market and coal volumes.

CSK is assuming modest economic growth; the stabilized domestic coal market and the current revenue per carload are expected to drive in higher revenue. With this, the company can achieve an average EPS growth of 10%-15% yearly by 2014-2015.

Being the largest railroad operator in North America, Canadian National is expected to benefit from the oil producers looking for alternative ways to bring their product to market due to insufficient pipeline capacity.

Considering the positive aspects and long-term sustainability, the companies are expected to show an upward trend in the coming years.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.