|
|
|
Investing in railroads
Railroads as an economic force and an investment tool
By Tom Murray
Published: Friday, July 07, 2006
To many of us, it's the physical attributes of railroading that make it an appealing industry. First, there's the geography. The rails that carry the hometown local freight, or the commuter train we ride every day, are part of a continuous network that allows cars to move from coast to coast and from the Northwest Territories of Canada as far south as the Mexican state of Chiapas. Then, there's the equipment. Trains and the motive power that pull them are a fascinating blend of mechanical engineering, industrial design, commerce and public relations.
Trains and the places they go may be the things that draw us to the rail industry, but it's money that causes railroads to exist in the first place and it's money that keeps them alive. Let's look at some key economic and financial facts about railroads and see what they tell us about how railroads have gotten where they are today, and where they are going.
In the late 19th century, railroads were the most important corporations in the United States. In 1884, Charles Dow came up with the first stock index designed to track the performance of the largest companies under public ownership. Nine out of the eleven firms in Dow's first index were railroads, including one company that survives today, Union Pacific.
In 1896, Dow separated the major stocks of that time into two indexes, one consisting of 12 industrial companies and the other containing 20 railroad stocks. The railroad index continued under that name until 1970, when it was renamed the Dow Jones Transportation Average. Today, this index still contains 20 stocks, but only four are railroads (Burlington Northern Santa Fe, CSX, Norfolk Southern and Union Pacific). The rest of the index consists of airlines, trucking firms and express services.
From being the major players in the original Dow index, to having their own separate index in 1896, to becoming part of a broader transportation index in 1970, to being only four out 20 stocks in that index today (and four out of 50 stocks, if you count the Dow Jones Industrials Average as well as the Transportation Average) - it's been a downward slide for the rails.
Another indication of the railroads' loss of stature in the investment community came in The Wall Street Journal of June 26, 2001. The Journal's "Best on the Street" survey, which recognizes investment analysts for their stock-picking and earnings-forecasting prowess, for the first time did not have a separate category for railroad analysts. Instead, that category has been rolled into "industrial transportation," which includes air freight, ocean shipping and trucking.
But those of us close to the rail industry know that it's experienced a turnaround in recent years. Anyone who lived through the rail bankruptcies of the 1970s or the years when no piece of track seemed safe from abandonment, knows that the railroads are healthier today than they've been in decades. Production data for the rail industry quantify this turnaround.
A commonly used measure is the revenue ton-mile (a ton of freight hauled one mile). In 1929, according to Association of American Railroads data, U.S. railroads generated 447 billion revenue ton-miles, or RTMs. The Great Depression hurt the railroads as much as any other economic sector and by 1939, annual tonnage was down to 333 billion RTMs. World War II revived the industry; by 1944, rail traffic had more than doubled, to 737 billion RTMs. That was a high-water mark for the industry, and traffic fell from the late 1940s until about 1960. In that year, the railroads generated 572 billion RTMs.
In the 1960s, volumes started to increase but it wasn't until the 1970s that annual figures in excess of 700 billion RTMs started to be recorded on a regular basis. Since 1980, traffic levels have taken off. In 1999 (the most recent year for which the AAR has published statistics) the railroads generated more than 1.4 trillion ton miles - 58 percent more than in 1979. By this measure, railroads seem to be enjoying an unprecedented level of prosperity.
Another way to look at railroads is to measure their share of the intercity freight market. Again using AAR data, we find that in 1929, railroads had 75 percent of the intercity freight market, measured in ton-miles. As the highway network was built up, trucks took a larger share of that market, and by 1970, the railroads' market share fell below 40 percent for the first time, while the trucks' share reached 21.3%. In the 1990s, railroads finally stopped the erosion of market share. From 1996 through 1998, the railroad's market share actually exceeded 40 percent.
Market share based on tonnage treats a pound of grain the same as a pound of semiconductors. Another way to look at market share is by the value of the freight carried. A 1993 study by the U.S. Department of Transportation data showed that, based on value, all-rail shipments represented only 4.0 percent of the U.S. freight market, with truck-rail intermodal shipments adding another 1.4 percent. Shipments that moved entirely by truck represented 71.9 percent of the total value of U.S. freight movements. Unfortunately, the value-based market share data aren't regularly updated, but it's a safe bet that with the growth of coal business on the rails, the rail number didn't improve much in the late 1990's.
As the U.S. economy has grown, it has kept on producing the kinds of things that railroads typically haul: coal, grain, chemicals, forest products, and other commodities that have a high ratio of weight to value. Because the population and the economy have grown in absolute terms, the need for these commodities has continued to increase, which has allowed the railroads to expand their traffic base. However, this growth has not kept pace with rest of the economy. And because railroads haul the lowest-value commodities, they have limited ability to improve their profitability by charging their customers higher prices.
The importance of value versus weight as an economic factor is one of the themes that Alan Greenspan, chairman of the Federal Reserve Board, kept returning to. He referred to this phenomenon as "the displacement of physical weight of output with concepts." More people are doing things that involve ideas (like writing computer programs) and a smaller percentage of the work force is involved in producing and using heavy, bulk materials. Those heavy commodities are losing out to smaller, lighter goods. Mr. Greenspan cited copper as an example. Much of the copper formerly used in electrical circuits has been displaced by electronic components that are not only smaller and lighter but also enable machinery to run at a much higher level of efficiency. Copper, of course, was once an important commodity for the railroads.
In other words, the railroad industry's major sources of revenue represent a declining share of the economic pie. More significantly, as heavy commodities (like steel) are replaced by lighter ones (like aluminum), the importance of inventory and logistics costs in the final value of products is greater than it was in the past. Railroads as they operate today are well suited to commodities that can stand significant variability in delivery schedules. Those, by definition, are low-value products. Motor carriers (in combination with air and express companies) have captured virtually 100 percent of the market for service-sensitive, high-value products.
The key question for the rail investor is whether there is hope for the industry in light of its shrinking role in the North American economy, and declining status in the eyes of the investment community. My view is that railroads are simply too important to fail. By that, I don't mean that the government will have to step in to save the railroads again, as it did with Penn Central and the other northeast bankrupts. Instead, I think that the boards of directors of one or more major railroads will realize that they have a responsibility to bring about dramatic change.
In the 1990's, railroads did a great job of building the physical infrastructure to take them into the 21st century. If they can do an equally good job of matching their services to the needs of the 21st century economy, rail investors will really have something to celebrate.
Tom Murray is a railroad consultant and TRAINS Magazine columnist. He can be contacted at tommurray@tmrail.com. |
|
|
Subscriber-only content
