Why These Rail Companies Offer a Rewarding Ride

Madhukar is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

So far this year railroad companies are performing better than in 2012. This is because of increased demand for natural resources like oil, gas, coal and lumber in the U.S. and Canada. The railroad companies are expanding their rail networks in these regions to capitalize on the new glut of potential resources, providing more efficient and better connectivity. Here are three railroad companies looking to increase their revenue from their different business segments.

Increased oil production will drive revenue higher

Union Pacific’s (NYSE: UNP) chemical segment reported $873 million in freight revenue, which represents about 17% of total freight revenue, in the first-quarter of 2013. Crude oil comprises 34% of the company's chemical carloads, and increased oil production in the U.S. will result in higher crude oil shipments.Oil production in the U.S. was 8.9 million barrels per day (bpd) as of June.

The Bakken and Eagle Ford shale formations in the U.S. are major oil-producing fields. The oil production in the Eagle Ford shale formation was 529,000 bpd in March, an increase of 77%, year-over-year.

The Bakken shale formation also showed an increase of 33%, year-over-year, producing 727,149 bpd in April. About 75% of this oil was shipped through railroads, and only 17% through pipelines. Union Pacific has well-connected railroad networks in these oil producing areas. Since there is a lack of oil pipeline network in these regions, the company is poised to benefit from this situation.

It also reported $3,225 in revenue per carload from its chemical segment, and expects its chemical carload to increase to 287,000 units in the second-quarter of 2013, up from 271,000 units in the previous quarter.

Freight railroad companies usually sign long-term contracts with many of their customers, but with the expiration of many of these "legacy" contracts, freight railroad companies are opting to sign short-term contracts at higher prices instead.

In the first-quarter, Union Pacific re-priced 80% of its $350 million legacy business that represented 1% to 2% of the company's total revenue. This is the first time It re-priced its legacy contracts since 2004. The company’s remaining re-pricing opportunity is worth $1 billion and is expected to generate 4% to 5% of total revenue through 2016.

Improved capacity and demand will generate incremental revenue

Canadian National Railway (NYSE: CNI) will increase capital expenditures in the Western Canada region. Extreme cold conditions and heavy snow slowed down operations in this region, resulting in a decline of the company’s first-quarter operating revenue of 2%, year-over-year. The company will increase the capacity in  the Edmonton-Winnipeg corridor. This initiative will lead to additional spending of $100 million, leading to $2 billion capital expenditures in 2013.

Under this initiative, a new section of double track will be laid down. Long sidings will be added to increase the capacity and a new route will be added on the Prairie North Line. This will avoid delays due to bad weather in the future. In the last two years, business in this corridor has increased by 20%. The increased capacity and addition of a new route will help Canadian National Railway to improve its revenue from the current level of $2.4 billion in the first-quarter of 2013.

The U.S. Census Bureau had already reported that housing starts in May were at a seasonally adjusted annual rate of 914,000. This is around 28.6% above the May 2012 rate of 711,000. This strong demand for new homes in the U.S. is because of the economic recovery and low mortgage rates. The increased construction will drive the demand of lumber in the U.S. This will provide a tailwind for Canadian National, as it is one of the largest carriers of forest products in North America.

China is the second-largest importer of Canadian lumber. In 2012, China accounted for 32% of British Columbia’s lumber exports. Lumber and panels accounted for 43% of revenue in Canadian National's forest-product segment of in 2012.

It is expected that increased demand for lumber in China and the U.S. will drive the company's forest-product segment. 

Increased domestic demand and expansion driving revenue

Demand of utility coal is increasing in the U.S. domestic market. The Illinois Basin reported an increased demand of coal for domestic use. The utility coal from Illinois Basin is priced around $3.5 per million British thermal units, or MMBtu. The increased demand of utility coal is a result of higher natural-gas prices, in the range of $4 to $5 per MMBtu. This trend will be beneficial for CSX  (NYSE: CSX), which is one of the major railroad carriers in this region.

It reported an increase in its Illinois Basin coal carloads, for domestic use, from 12% in 2010 to 28% in the first quarter of 2013. CSX has seen a significant shift in demand for its utilities to Illinois Basin coal from Central Appalachian coal, as Illinois Basin acts as a source of low-cost utility coal.

Demand for domestic coal will further increase due to high natural-gas prices and weather conditions. The total coal consumption in the U.S. is forecast to increase from 890 million short tons, or MMst, in 2012, to 954 MMst in 2013. The company anticipates an increase in its domestic coal shipments, as Illinois Basin miners are willing to ship more of their low-cost coal.

CSX began construction of its Quebec Intermodal terminal in March. This new terminal will connect the Montreal region and Quebec with CSX's 21,000 mile rail network in the U.S. The terminal is expected to be operational by 2015. CSX will spend $107 million on this project in order to tap business opportunities from shippers in Montreal and Quebec City. The shippers, through this terminal, will have quick and efficient access to markets across the U.S. The terminal will be able to handle up to 100,000 containers per year. With this expansion, CSX has huge potential to acquire a good market share in intermodal business.

Conclusion:

Wide rail networks in the major oil fields of Bakken and Eagle Ford shale formations will increase Union Pacific's revenue in 2013. The company will also re-price its legacy contracts, which will increase revenue in long term, through 2016. I recommend buying this stock.

Canadian National Railway, one of the largest carriers of forest products in North America, will generate additional revenue in 2013 because of high demand for lumber in China and the U.S. Also, by increasing the capacity and adding new route in the Edmonton-Winnipeg corridor, the company aims to increase its revenue in 2014. I recommend buying this stock.

CSX will ship more coal from Illinois basin due to increased demand from its utilities. This will generate more revenue in 2013. With new intermodal terminal, the company has huge potential to drive its revenue higher from 2015. I recommend buying this stock.

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Madhu Dube has no position in any stocks mentioned. The Motley Fool recommends Canadian National Railway. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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