Rail Thesis Remains, But Challenges Persist in 2008
Surely, moving goods by rail is more fuel efficient than by individual truck, and in some cases (such as grain and coal), railroads are the only game in town. But investors need to be realistic about how far this thesis can translate into profits in the short run.
If the price of diesel is too high, it stands to reason that America’s retail stores will be selling less merchandise. After all, the shopping centers of the country are usually a fair drive from everyone’s homes. So if there is less aggregate demand by consumers, some of the rails’ customers will certainly be ordering less products.
The weekly data from companies like BNSF Railway has been showing weak container volume for well over a year already. Although the media likes to focus on coal, corn, and chemical shipments, the railroads still move a lot of consumer goods. In fact, companies like Canadian National Railway have seen reductions in auto shipments by up to 30% in the second quarter, versus 2007. Other merchandise, such as paper and lumber, have seen pretty lousy years as well.
And we can’t overlook the pathetic housing market, which impacts shipments of a host of building materials. After a horrible 2007, BNSF is reporting lumber shipments on the railway down another 30% in 2008. It goes to show how absolutely terrible the construction market is. Don’t believe otherwise, if you believe the rail data!
Maybe the market is just forward looking and is anticipating a rebound of volumes in 2009, but some of these economically sensitive areas just aren’t having good volume trends at the moment. The good news is that the railroads have been posting good earnings despite weak volumes in many areas. For shareholders, this is clearly the most important metric.
At the risk of sounding gloomy, I think the North American railroads will enjoy success for the next several decades, but investors should not get too accustomed to 40-50% moves every year. These types of price advances are simply not sustainable in light of weak volume trends across many business lines. It is ironic that rising energy prices are helping to test the thesis that rising energy prices are good for rails. As with most things, that thesis has some grey area and room for debate.
Mike Rubsam is President of Liberty Steward Capital, LLC (http://www.libertystewardcapital.com), and is long shares of BNI.
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