Railroads Achieve Record Results In 2014

|
Includes: BRK.A, BRK.B, CNI, CP, CSX, IYT, KSU, NSC, UNP, WEAT, XTN
by: Michael Hooper

Summary

Railroads experience their best year since 2007.

An uptick in grain prices may cause farmers to ship more grain.

Which railroad gets the biggest bang for the buck with capital investments?

North American railroads have achieved record results in 2014, but face many challenges in 2015.

Railroads may get slammed this winter with increasing orders from farmers to ship wheat, corn and soybeans. Farmers have been storing their crops waiting for better prices. Wheat prices are up about 25% from yearly lows in late September, partly due to new diplomatic relations between the United States and Cuba. The Teucrium Wheat Fund (NYSEARCA:WEAT) is up 25% in the past three months.

Railroads are ending 2014 with a bang, as they experience more growth in volumes in December. Total U.S. rail carloads were up a whopping 12.1% during week ending Dec. 13, 2014, and up 3.8% YTD. Intermodal traffic was up 4.5% for the week and up 5.2% YTD. Shipment of grain was up 17% for the week and up 13.4% YTD. A good sign for U.S. manufacturing was shipment of metallic ores and metals were up 24% for the week and up 3.8% YTD.

I have been watching these weekly railroad volumes at the Association of American Railroads for many years, and I would have to say 2014 was the best year for rail since 2007. I expect railroads to report record results for both the fourth quarter and all of 2014. Here's what AAR Senior Vice President John T. Gray said,

America's railroads are moving an enormous amount of freight today. In the first 10 months of 2014, total U.S. carload plus intermodal volume was 24.3 million units, which is more than 1 million units higher than in the first 10 months of 2013 and the highest year-to-date total since 2007.

Class I Rail stocks are up 17% to 41% year to date. The iShares Transportation Average ETF (BATS:IYT) posted a 24% gain YTD and the SPDR S&P Transportation ETF (NYSEARCA:XTN) achieved a 32% gain YTD gain. These ETFs own railroads, trucking, airlines and logistics companies. Railroads represent 26% of holdings in IYT and 13% of XTN.

Transportation stocks are sensitive to the economy. When the U.S. economy tanked in 2008-09, transportation stocks were among the hardest hit. However, 2014 is going down as one of the best years for the U.S. economy in recent history.

The U.S. Bureau of Economic Analysis raised its view of economic activity in the third quarter, saying GDP grew 5% in the third quarter, from the previous first estimate of 3.9%.

Rail volumes have been telling me GDP would be 4% or better. Through the first 50 weeks of the year, U.S. rail carloads were up 3.8% and intermodal up 5.2%. GDP grew at a rate of 4.2% in the second quarter of 2014, according to the "second" estimate released by the Bureau of Economic Analysis. In the first quarter, real GDP decreased -2.1% due to the hard winter last year.

In a recent presentation, Union Pacific (NYSE:UNP) said it has achieved YTD best-ever operating revenue, operating income, operating ratio and earnings. Living about a mile from the Union Pacific Railroad tracks, I can attest to its nonstop operations, I hear the train whistle all day long and nearly all night long. Here is what Union Pacific CEO Jack Koraleski said about the last quarter of 2014.

We are optimistic about the remainder of the year. Assuming the economy and weather cooperate, we are well positioned to finish up the year with record results.

Other railroads like BNSF Railway (owned by Berkshire Hathaway (NYSE:BRK.B)), Canadian National Railway (NYSE:CNI), CSX (NYSE:CSX), Norfolk Southern (NYSE:NSC), Kansas City Southern (NYSE:KSU) and Canadian Pacific (NYSE:CP) will also report excellent results in 2014.

BNSF Railway, a heavy mover of coal, saw coal volumes increase 1.13% YTD through Dec. 6. BNSF and Union Pacific move Powder River Basin Coal from Wyoming -- a cheaper, low-sulfur burning coal compared to Appalachian coal.

Norfolk Southern's total carloadings to date through Dec. 7 was 7,382,741, up 311,811 carloads or 4.4% over same time period in 2013. Coal carloads were down -5.9% but the company is making up for coal losses through growth in intermodal, grain and petroleum.

At CSX, shipment of petroleum products climbed 62.5% to a record 203,956 carloads YTD through Dec. 7. During Week 50, CSX hauled 5,633 petroleum carloads, up 69% from a year ago. Petroleum products represent 5% of carloads (excluding intermodal). CSX total carloads and intermodal were up 5.8% YTD.

Crude-by-rail outlook

In the near term, I don't expect crude-by-rail volumes to change due to the sharp drop in oil prices, but if low oil prices persist, we may see a decline in crude-by-rail volumes from shale plays. SA writer Michael Fitzsimmons says real Bakken production in October was down month over month.

If there is a significant decline in crude-by-rail from the Bakken, I expect CP and BNSF to feel it first and foremost, and secondly, the other carriers like CSX, NSC, UNP and KSU. In Week 49 of UNP's business, shipment of petroleum products was down -5% to 6,049 carloads compared with 6,392 carloads in Week 49 of 2013.

Looking at the weekly carloads by line of business at Canadian Pacific's web site, I saw CP's crude volumes have been fairly steady at around 2,600 carloads per week, but fell to 1,666 carloads week ended Nov. 15, then climbed back to 2,687 carloads week ended Dec. 13.

BNSF Railway's petroleum shipments have trended up from 10,453 carloads in Week 1 of 2014 to 11,116 carloads in Week 49. A high point was an amazing 12,153 carloads of petroleum shipped during Week 43 ended Oct. 25.

YTD petroleum shipments by BNSF was 533,391 carloads, up 12.87% over 2013. That is a huge increase. BNSF's 533,391 YTD petroleum shipments represent 10.6% of YTD 5,005,911 total carloads, or 5.5% of intermodal and carload units.

ROIC Measures

Return on invested capital is a tool used to determine how well a company is allocating capital to generate returns. ROIC equals net income minus dividends divided by total capital.

Company

Return On Invested Capital 2013

Return On Invested Capital Trailing 12 Months

Union Pacific

15.80

16.62

Canadian National

14.84

15.87

Norfolk Southern

11.48

11.61

CSX

11.44

11.15

Canadian Pacific

10.07

9.72

Kansas City Southern

7.86

9.64

Berkshire Hathaway

7.86

7.83

Union Pacific is clearly the winner in ROIC. UNP achieved 16.62% return on invested capital in the trailing 12 months. Only Canadian National Railway comes close. If UNP continues its strong track record of ROIC, the company's capital investments should really pay off in 2015.

Capital Plans

Not all Class I railroads have announced capital plans for 2015, but it is safe to say they probably will be investing more than they did in 2014, due to rising demand for rail services and a growing economy. AAR says in 2014, freight railroads were expected to spend $26 billion - to purchase new equipment and improve rail lines and facilities, upgrade signal control systems, replace aging bridges, expand the capacity of intermodal yards and launch new trail control systems.

BNSF Railway's capital expenditures for 2015 will be a record $6 billion for maintenance and expansion of the railroad in order to meet the expected demand for freight rail service. The company spent $5.5 billion in capital improvements in 2014.

BNSF plans to spend almost $1.5 billion on expansion projects. Nearly $500 million of that expansion work will occur in the Northern Region, where BNSF is experiencing the fastest growth. That region primarily serves agriculture, coal, crude oil and frac sand for oil exploration and production.

BNSF will acquire 330 new locomotives to add to its fleet of 7,500 and replace others that will soon reach the end of their useful life. Diesel mechanics and electricians are in demand at the BNSF locomotive shops in Topeka, KS.

Union Pacific was expected to invest approximately $4.1 billion in 2014 on its 32,000 mile network.

CSX was expected to spend $2.3 billion in 2014. About 90% of CSX's intermodal traffic moves on double stack cleared lines and that percentage will grow. My cycling friend, Brian Carr, a longtime trucker, says,

You know the economy is growing when you see double stacks of containers on the railroad.

Norfolk Southern planned to spend $2.2 billion in 2014 capital investments, 12% above its 2013 numbers.

In 2014, CN was expected to spend a $2.1 billion to raise network safety and efficiency, improve service and grow business.

Canadian Pacific was expected to spend $1.2 billion to $1.4 billion in capital expenditures in 2014.

Conclusion

Class I railroads will experience a flurry of business in 2015. However, congestion may slow growth, especially if there is a long snowy winter and a massive influx of grain shipments. In recent years, Canadian National Railway has invested quite a bit of money in snow clearing equipment. Winter in Canada can be deathly long and cold.

If grain prices continue to climb, farmers will open their grain bins and haul grain by truck to the elevators, where the grain is loaded into rail cars. Some of this grain will go to ethanol producers, which love low grain prices. A lot of the grain will go overseas. Union Pacific is well positioned to move a lot of grain in 2015 with its huge network of rail in the Midwest. Let's hope the weather cooperates and railroads are able to meet farmers' demands. Even if weather is mild this winter, I expect a continuation of congestion in the Northern Transcontinental Railway and Chicago, where capital improvements are badly needed. Railroads will spend billions of dollars in 2015 to improve their rail networks. Union Pacific has the highest return on invested capital. We may see some reduction in congestion if crude-by-rail volumes decline. However, the numbers from most railroads, including BNSF Railway, show there has been no decline in crude-by-rail volumes due to lower oil prices. BNSF Railway is the kingpin of crude-by-rail, growing this segment by 12.87% in 2014 and expects to grow it even further in 2015.

Investors are wise to hold onto their rail stocks and look for dips in stock prices to add to your positions. Investors may want to consider owning the ETFs, IYT and XTN, to gain exposure to the broader transportation sector. Transports should continue to perform well in 2015 if the economy maintains its current momentum.

Disclosure: The author is long BRK.B, UNP, NSC, CNI, CP.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.