3 Railroad Companies Back on Track

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In the last five years, the government’s infrastructure initiatives and tax credits have driven railroad companies in North America to spend more than $50 billion on improving and building new tracks for better connectivity. This capital expenditure has helped the trains to travel all across North America. A railroad company’s revenue is mainly driven by its chemical, coal, and intermodal segments. These companies are facing problems in coal shipments, as the demand for the coal has decreased due to the availability of natural gas at a cheaper price.

I have analyzed three railroad companies, as these companies are looking to enhance their revenue by spending on improving and adding new routes.

Oil shipments and re-pricing of old contracts enhance revenue

According to the Association of American Railroads, crude oil shipments by U.S. railroads tripled in 2012 to 233,811 carloads, which resulted in a 46% annual rise in crude oil and petroleum product shipments by U.S. railroads. Growth in crude oil production and places where pipeline infrastructure is not adequate to transport oil helped in the growth of crude oil shipments made by the railroad.

Union Pacific (NYSE: UNP)'s chemical segment reported a freight revenue growth of 14% year over year in the first quarter ending in March 2013, which is contributing nearly 18% to the total freight revenue. This growth was mainly driven by the increase in crude oil shipments, holding the highest proportion of 34% of its chemical carloads. Its crude oil shipments grew more than 90% in 2012 and are expected to grow significantly in 2013, as the crude oil production is expected to exceed pipeline capacity. Its rail line is well connected with the oil-producing areas such as Bakken, Permian, and Eagle Ford Shale formations.

These oil fields – especially Bakken, which lacks an oil-transportation pipeline system – are likely to drive the company’s oil-shipment business. Union Pacific hauled 325,000 barrels per day in the first quarter of 2013 from Bakken. Crude oil production in the U.S. is expected to reach 7.05 million barrels per day in 2013 and the Bakken and Eagle Ford contribute two-thirds of the U.S. oil production, which will help it to drive its revenue higher. The company is charging an average fare of $3,225 per carload for its chemical segment.

Moreover, Union Pacific, to improve its overall revenue, is focusing on re-pricing its legacy contracts. The rail re-pricing remains the key driver supporting the growth of the rail freight company. It has re-priced 80% of its $350 million legacy business in the first quarter of 2013, which has not been re-priced since 2004. This re-pricing contributed around 1.5% of the total revenue. The remaining re-pricing opportunity is worth $950 million, which is estimated to generate around 4%-5% of the total revenue through 2016 and, out of which 85% of the remaining legacy contracts are of coal.

Nearly 30% of the coal contracts have one year left and it is expecting a rebound in domestic coal demand, as natural gas prices are trading above $4 per million metric British thermal unit, or MMBtu, compared to coal prices of $2.40 per MMBtu. This re-pricing of the freight contracts will enhance the revenue of the company continuously through 2016.

New agreement will increase coal shipment business

Canadian National Railway (NYSE: CNI), to enhance its coal shipment segment, signed a seven-year memorandum of understanding with Coalspur Mines that began on Jan. 01, 2013. This agreement will provide synergy to the company to boost its coal shipment revenue. In this agreement, the company will supply the equipment to carry Coalspur’s coal to tidewater, as well as construction of a 6.5 km railway track to serve its mine. The key element of this contract includes transportation of more than 12 million tons per annum, or Mtpa, of coal. The company is anticipating revenue of $1,712 per carload and, overall, it is expected to generate $740 million from its coal segment for fiscal year 2013.

Canadian National has reiterated its 2013 guideline to achieve a high single-digit EPS growth with a 3%-4% carload growth and higher-revenue ton-miles. To achieve this target, the company has planned for capital expenditures of $1.9 billion in 2013. It will spend $1 billion on track infrastructure, $700 million to expand its business, and $200 million on acquisition of locomotive and intermodal equipment.

Severe winter conditions in Winnipeg last year led to a 2.2% decline in its operating revenue in the first quarter of 2013. It has planned to spend an additional $100 million to improve infrastructure between Edmonton-Winnipeg corridors by including double-tracking railway lines in the Saskatchewan region, which will improve the network resilience during winters.

The company will also add long sidings which will give it an additional route and increase capacity. Business in this corridor, in the last two years, increased by 20%, and the flow of traffic has moved toward the company. This flow is considered a good sign for the company and will improve its future revenue growth.

Capital expenditure to enhance footprints

CSX (NYSE: CSX), with the target of increasing its coal shipments, has shifted its utilities to more competitive coal-sourcing regions, especially Illinois basin coal. This basin has contributed an overall shipment volume of around 29% in the first quarter of 2013, compared with 25% in 2012 and 12% in 2010. The company expects the Illinois basin will help in building a strong coal portfolio, as the coal price of the Illinois basin is more competitive and trading around $3-$3.5 per MMBtu when compared to the natural gas price, which is trading above $4 per MMBtu. It anticipates a positive impact on its coal shipments, as the higher natural gas price and a colder winter will increase the demand for coal consumption and provide relatively stronger coal shipment traffic.

On the other hand, it has spent $7.8 billion on its network in last four years and is planning for $2.3 billion capital expenditure in 2013. This expenditure will be used on the development of the National Gateway route. This is the key freight rail corridor, connecting Mid-Atlantic coast ports to the upper Midwest distribution points and population centers. The company is planning to develop new tracks on the National Gateway line so that it can offer competitive rail rates compared to trucks. This new track will also connect CSX operations at the APM terminal, permitting shippers to access the upper Midwest. CSX is looking to gain market share in the containers segment, as the Baltimore port, which is the takeoff point of the CSX National Gateway route, carries only 4% along the east coast.

Since 2005, CSX has increased its quarterly dividend 11 times, representing the compounded annual growth rate of 29%. The company has increased dividend for this quarter by 7% to $0.15, or $0.60 on an annualized basis, compared to its annualized dividend of $0.56 in last year. The dividend yield of the company is 2.4%, which is higher than the Dow Jones Transports dividend stocks, yielding 1.9%.

Conclusion

Union Pacific, with its wide network in shale oil and the re-pricing of its legacy contract, will increase revenue in the long term.

Canadian National, with its Coalspur agreement of seven years and the capital expenditure in the Edmonton-Winnipeg will enhance its future shipments.

CSX, with capital expenditure of $2.25 billion in 2013 on the National Gateway line and its move towards the Illinois coal basin, will boost its coal shipment revenue.

I recommend buying all these stocks.

With 21,000 miles of track serving two-thirds of the U.S. population, CSX maintains a valuable proprietary asset. Still, this railroad will face difficult obstacles in the years ahead due to a domestic surplus of natural gas and coal’s declining popularity. To help investors better understand how CSX can deal with these challenges, The Motley Fool has released a brand-new premium research report authored by Isaac Pino, Industrials Bureau Chief and transportation expert. Isaac provides an in-depth look at CSX’s competitive advantages, risk areas, and prospects for the future. Simply click here now to access your copy of this invaluable investor's resource.


Shweta Dubey 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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