Railroads Cope With Port Congestion And Oil Uncertainty

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Includes: BRK.B, CNI, CP, CSX, KSU, NSC, UNP
by: Michael Hooper
Summary

Canadian railroads see influx of business due to U.S. port congestion.

International containers are moving through Port of Vancouver, Port of Montreal and Port of Prince Rupert as shippers steer away from Long Beach and Los Angeles.

Kansas City Southern is bullish on crude from Canada, hurt by peso drop.

North American railroads achieved tremendous gains in 2014 but face several challenges in 2015. Questions remain about whether oil by rail has room to grow. Western railroads Union Pacific (NYSE:UNP) and BNSF Railway, owned by Berkshire Hathaway (NYSE:BRK.B), may lose business due to congestion and work slowdowns amid union negotiations at West Coast ports. Meanwhile, Canadian railroads have picked up additional international intermodal business that normally would go through U.S. ports.

The congestion at Long Beach and Los Angeles has reached the "crisis stage," according to the Journal of Commerce. Twenty ships are anchored off the shore of Long Beach for up to two weeks. Unloading a ship can take eight days due to work slowdowns.

Overwhelmed by congestion and hampered by International Longshore and Warehouse Union work slowdowns, West Coast ports saw their container volume drop 6% in December, the Journal of Commerce reported.

BNSF Railway says it can provide service from Los Angeles to New York in under 80 hours. But shippers are finding other ways to transport goods to the East Coasts.

In 2014, the West Coast ports were barely able to register a 1% gain in container volume, while container volume in New York-New Jersey grew 5.4% in 2014. East Coast railroads CSX Corp. (NASDAQ:CSX) and Norfolk Southern (NYSE:NSC) experienced a 5% increase in intermodal revenue in 2014 over 2013.

Union Pacific leadership is worried about West Coast port congestion and work slowdowns if there is no resolution between the International Longshore and Warehouse Union and the Pacific Maritime Association. Union Pacific's intermodal revenue was up 11% to $1.13 billion in 2014, on the strength of Domestic shipping growing 10% while International grew 2%. Half of UNP's intermodal business is domestic and the other half international.

Canadian National Railway (NYSE:CNI), Canadian Pacific Railway (NYSE:CP) experienced a flurry of international intermodal business in the fourth quarter due to labor disputes at U.S. West Coast ports.

Canadian National Railway's JJ Ruest, executive vice president and chief marketing officer with CN, said the company's intermodal business grew 7% driven by a gain in the international business equally split between the Port of Vancouver, Port of Montreal, and the Port of Prince Rupert. And CN ended the quarter with a very strong momentum at Vancouver and Prince Rupert.

Canadian Pacific's CEO Hunter Harrison and Bart Demosky, chief financial officer and executive vice president, both talked about the influx of business to the Port of Vancouver as a result of problems in U.S. ports during their 4Q conference call. Says, Demosky, "With that increased business also comes some increased headaches that have driven some operational cost that I am not very happy about. We were actually reviewing that yesterday and looking at Vancouver's terminal. So, I would much rather have something that's ratable to sustainable that we can plan for that I can control the cost on. So there is positives there is negatives, I would say it's net neutral."

And Harrison, "I think one of things that focused our attention on even further is the fragile-ness of Vancouver Gateway. We had some shift of business to Keith's point, not a huge amount but just pick a number 10% 15% and it's created whole lot of problems. So if you think out in the future and say going to have a growth over the next five years, 10 years, 15 years where is it going to be? We have to do something at Canadian ports to be more competitive."

Oil the game changer

Railroads in North America are at the top of a game-changer in rail history. That game changer is oil by rail. In six years, oil by rail went from almost nothing to 5% of the business of North American railroads.

The U.S. economy slowed down in the fourth quarter to 3% growth in GDP compared to the outstanding 5% GDP growth in the third quarter. Low gas prices have encouraged consumers to buy trucks and SUVs and other vehicles. Railroads will be hauling autos and trucks from manufacturing sites in Detroit, Kansas City and Mexico.

Truck-to-rail conversions have led to multiple years of growth in intermodal business for railroads. Railroads have developed intermodal sites across the country where they can load and unload truck trailers and shipping containers. These new parks such as Logistics Park Kansas City have energized the intermodal shipping industry.

Grain, oil and intermodal business are growing for Canadian National Railway, Canadian Pacific Railway and Kansas City Southern (NYSE:KSU). These three companies are well positioned to benefit from growing international trade routes while competing with other carriers. Canadian National Railway is the strongest of the three and owns the largest amount of track with connections to the Pacific, Atlantic and Gulf of Mexico.

Grain and oil drove Canadian National Railway to post tremendous gains in the fourth quarter and all of 2014.

CN Q4-2014 diluted earnings per share increased 36% to C$1.03 from diluted EPS of C$0.76 for the final quarter of 2013. Full-year 2014 volumes reached record levels, with carloadings up 8% and revenue ton-miles up 10%.

"Given CN's strong balance sheet and its solid outlook for earnings and free cash flow generation, I am pleased to announce that the Company's Board of Directors has approved a 25% increase in CN's 2015 quarterly common-share dividend. CN has increased its dividend per share by 17% per year on average since its privatization in 1995," said Claude Mongeau, CN president and chief executive officer.

JJ Ruest, executive vice president and chief marketing officer with CN, said the first revenue driver was grain. CN's grain business was up 14%.

Second revenue driver for CN in the fourth quarter was its crude business, which was up over 40%. CN moved a total of 34,000 carloads in the quarter and approximately 128,000 carloads of crude for the year. Last year in every quarter, CN moved more crude carloads than Canadian Pacific.

Kansas City Southern

In the fourth quarter, Kansas City Southern reported U.S. $1.27 earnings per share, beating estimates by $0.04 but revenue of $642 million missed estimates by $16.47 million.

Compared to 2013, fourth quarter revenue growth at KSU was led by a 13% increase in Automotive and a 9% increase in both Chemicals & Petroleum and Energy. Intermodal was also strong, with revenues growing by 8% in the fourth quarter of 2014. Industrial & Consumer revenue grew 1% and Agriculture & Minerals revenue declined by 5% compared to the prior year, primarily due to a decline in grain shipments when compared to the exceptionally strong fourth quarter of 2013. Also, the impact of lower U.S. fuel prices and the depreciating peso reduced revenue growth by approximately 2% compared to the fourth quarter of 2013.

In early January, Kansas City Southern hosted a series of customer meetings in the Port Arthur, Texas, Beaumont, Texas, and Baton Rouge , LA, with several of its key customers, particularly those that are going to be the primary drivers of our growth in 2015. These meetings included Canadian oil producers, U.S. refiners, terminals and transportation entities.

"The key takeaway from our customer visit was that at/or even below current price levels, producers and refiners still plan to move Canadian crude to the U.S. Gulf Coast," said Pat Ottensmeye, KSU executive vice president of Sales and Marketing. "You've also seen that prices have fallen and spreads have narrowed, but because of the combination of factors including production commitments, infrastructure investments, hedge positions, our crude-by-rail business has gained strength from a year ago and we expect it to grow over the course of 2015 and beyond."

Ottensmeye said the infrastructure on the receiving end of Kansas City Southern's network continues to develop in the form of track, steaming capabilities and unloading capacity to handle multiple trains per day. KSU's crude business will be primarily driven by Canadian crude to the U.S. Gulf Coast, as KSU has not moved any significant volumes of Bakken crude oil for over a year now.

Kansas City Southern lowers guidance due to drop in the peso against strong U.S. Dollar.

"It doesn't necessarily feel good to us to tell you that our revenue growth is going to be in the mid single-digit range for 2015," Ottensmeye said. "So, hopefully, you will understand that statement is heavily influenced by factors that do not reflect the strength of our core business. We are still very positive about the outlook and absolutely no less bullish about the long-term growth prospects for KCS. Business demand right now is strong. The economy appears to be gaining momentum. Our cross-border franchise is extremely well-positioned to benefit from growth in industrial activity in the U.S. Gulf Coast, south eastern markets in the U.S. and in Mexico."

Capital spending in 2015

U.S. freight railroads plan to spend an estimated $29 billion on the nation's rail network, and project to hire about 15,000 people in 2015, the Association of American Railroads reported in its 2015 Outlook. These high-paying jobs, and record private spending will further strengthen an essential transportation system that is today powering a U.S. economic comeback.

"By providing affordable, efficient and reliable transportation of goods, from lumber to oil to auto parts and grain, freight railroads continue to play a vital role in the positive economic trends rippling through the U.S. economy - including rising gross domestic product, improving employment statistics and plummeting gasoline and heating prices," said AAR President and CEO Edward R. Hamberger.

Conclusion

Railroads are coming off one of the best years in recent history. Achieving gains in 2015 will be challenging but can be done if railroads go where there is realistic and reliable business. Canadian Pacific leadership complained about the "headaches" of getting additional business in Vancouver due to port congestion in the U.S. Some businesses would gladly accept the additional business. I suggest you take advantage of the situation rather than complaining about the headaches.

I expect intermodal to provide tailwinds to East Coast railroads CSX and Norfolk Southern. They may be able to achieve another 5% gain in intermodal revenue in 2015. Questions remain about the growth of oil by rail. But even if it doesn't grow in 2015, I believe oil by rail is here to stay. It is the easiest way to move oil to market where there is no pipeline. Some shale plays may go idle in 2015 if oil price doesn't recover but there is still plenty of business out there.

The United States is clearly losing business to Canada if we don't see a settlement between the International Longshore and Warehouse Union and the Pacific Maritime Association. Canadian National Railway is best positioned to take advantage of the U.S. port problems. Canadian National Railway owns tracks to the Pacific Ocean, the Atlantic Ocean, Chicago and the Gulf of Mexico.

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