Earnings Recap: One Railroad Stands Out

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The country’s major railroad companies recently came out with their 4th quarter and 2012 full year earnings. The amount of exposure to the weak coal markets helped discern the winners and losers among the rail companies. Low supplies of corn negatively affected agricultural revenue throughout the industry. Housing helped drive industrial product revenues, and oil demand continues to drive chemical freight. Overall, the western railroads won out in 2012:

<table> <tbody> <tr> <td colspan="5"> <p><strong>Consolidated 2012 figures</strong></p> </td> </tr> <tr> <td> <p> </p> </td> <td> <p><strong>Norfolk Southern <span class="ticker" data-id="204749">(NYSE: <a href="http://caps.fool.com/Ticker/NSC.aspx">NSC</a>)</span></strong></p> <p><strong>(East)</strong></p> </td> <td> <p><strong>CSX </strong></p> <p><strong><span class="ticker" data-id="203228">(NYSE: <a href="http://caps.fool.com/Ticker/CSX.aspx">CSX</a>)</span></strong></p> <p><strong>(East)</strong></p> </td> <td> <p><strong>Kansas City Southern <span class="ticker" data-id="204195">(NYSE: <a href="http://caps.fool.com/Ticker/KSU.aspx">KSU</a>)</span></strong></p> <p><strong>(Midwest)</strong></p> </td> <td> <p><strong>Union Pacific <span class="ticker" data-id="205900">(NYSE: <a href="http://caps.fool.com/Ticker/UNP.aspx">UNP</a>)</span></strong></p> <p><strong>(West)</strong></p> </td> </tr> <tr> <td> <p>Yearly revenue growth</p> </td> <td> <p>(1%)</p> </td> <td> <p>0.1%</p> </td> <td> <p>7%</p> </td> <td> <p>7%</p> </td> </tr> <tr> <td> <p>Yearly operating income growth</p> </td> <td> <p>(3%)</p> </td> <td> <p>1%</p> </td> <td> <p>17%</p> </td> <td> <p>18%</p> </td> </tr> <tr> <td> <p>Operating ratio</p> </td> <td> <p>72%</p> </td> <td> <p>71%</p> </td> <td> <p>68%</p> </td> <td> <p>68%</p> </td> </tr> <tr> <td> <p>Yearly net income growth</p> </td> <td> <p>(9%)</p> </td> <td> <p>2%</p> </td> <td> <p>15%</p> </td> <td> <p>20%</p> </td> </tr> <tr> <td> <p>Yearly operating cash flow growth</p> </td> <td> <p>(5%)</p> </td> <td> <p>(16%)</p> </td> <td> <p>6%</p> </td> <td> <p>5%</p> </td> </tr> <tr> <td> <p>Yearly free cash flow growth</p> </td> <td> <p>(12%)</p> </td> <td> <p>(45%)</p> </td> <td> <p>(3%)</p> </td> <td> <p>(8%)</p> </td> </tr> <tr> <td> <p>P/E ratio</p> </td> <td> <p>13</p> </td> <td> <p>12</p> </td> <td> <p>28</p> </td> <td> <p>16</p> </td> </tr> <tr> <td> <p>Dividend growth</p> </td> <td> <p>28%</p> </td> <td> <p>20%</p> </td> <td> <p>100%</p> </td> <td> <p>29%</p> </td> </tr> <tr> <td> <p>Dividend to free cash flow payout</p> </td> <td> <p>61%</p> </td> <td> <p>71%</p> </td> <td> <p>58%</p> </td> <td> <p>45%</p> </td> </tr> </tbody> </table>

Source: Compiled from SEC documents

Consolidated look

In the table above, Union Pacific and Kansas City Southern increased their revenue the most and possess the highest levels of efficiency.  Kansas City Southern and Union Pacific lead the way on operating cash flow growth increasing 6% and 5% respectively.  Union Pacific and Kansas City Southern also paid out the least amount of free cash flow in dividends further highlighting cash prudence.

Segmented look

1.) Coal - Weaknesses in the coal market put a dent in the revenue of every railroad discussed here. In the table above, the biggest 2012 losers, Norfolk Southern and CSX, experienced a 1% decline and a 0.1% increase respectively in revenue. The coal segment as a percentage of total revenue for Norfolk Southern and CSX clocks in at 26% and 27% respectively.

At the same time, the biggest winners garnered the least amount of revenue from coal. Kansas City Southern and Union Pacific increased 2012 overall revenue 7% (consolidated table above). Percentages of 2012 revenue from coal for Union Pacific and Kansas City Southern came in at 20% and 11% respectively.

<table> <tbody> <tr> <td colspan="5"> <p><strong>Coal segment revenue change for 2012</strong></p> </td> </tr> <tr> <td> <p> </p> </td> <td> <p><strong>Norfolk Southern</strong></p> <p><strong>(East)</strong></p> </td> <td> <p><strong>CSX</strong></p> <p><strong>(East)</strong></p> </td> <td> <p><strong>Kansas City Southern</strong></p> <p><strong>(Midwest)</strong></p> </td> <td> <p><strong>Union Pacific</strong></p> <p><strong>(West)</strong></p> </td> </tr> <tr> <td> <p>Coal</p> </td> <td> <p>(17%)</p> </td> <td> <p>(14%)</p> </td> <td> <p>(13%)</p> </td> <td> <p>(4%)</p> </td> </tr> </tbody> </table>

Source: Compiled from SEC documents

Union Pacific’s coal revenues declined 4% representing the lowest decrease of the four railroad companies discussed (see table above). The increase in western coal freight revenue served as a buffer to its decline.

Natural gas prices remain low which means electric utilities will continue to give preference to it over coal, specifically central Appalachian coal. Even if natural gas prices rise, utilities may operate under a contract to utilize natural gas for some time, so the lag may last a while before the switch back to coal can happen. In essence, the coal segment will remain under pressure for some time.

<img src="http://media.ycharts.com/charts/fa6a837d77a352712192df3ef4a9a885.png" />

US Natural Gas Wellhead Price data by YCharts

2.) Agriculture – Low corn supplies stemming from last year’s drought provided a boon to the American farmer and fertilizer companies such as Potash and Intrepid Potash; however, it hurt agricultural railroad freight with fewer crops to haul.

The railroad companies operating in the predominantly agricultural midwest and western states experienced the largest loss in agricultural revenue. Kansas City Southern, which operates predominantly in the Midwest, experienced a 3% drop in agricultural freight revenue. Union Pacific, a mostly western railroader, experienced a 1% decrease in the segment. 

<table> <tbody> <tr> <td colspan="5"> <p><strong>Agricultural segment revenue change for 2012</strong></p> </td> </tr> <tr> <td> <p> </p> </td> <td> <p><strong>Norfolk Southern</strong></p> <p><strong>(East)</strong></p> </td> <td> <p><strong>CSX</strong></p> <p><strong>(East)</strong></p> </td> <td> <p><strong>Kansas City Southern</strong></p> <p><strong>(Midwest)</strong></p> </td> <td> <p><strong>Union Pacific</strong></p> <p><strong>(West)</strong></p> </td> </tr> <tr> <td> <p>Agricultural</p> </td> <td> <p>0.5%*</p> </td> <td> <p>(0.5%)</p> </td> <td> <p>(3%)</p> </td> <td> <p>(1%)</p> </td> </tr> </tbody> </table>

*Includes agriculture/consumer/government
Source: Compiled from SEC Documents

Members of the farming community anticipate a number of new growers next season. In the absence of drought conditions a higher supply of corn and other crops will boost this segment.

3.) Automotive – The double digit gains in automotive freight for all four companies give evidence of the improving macro-economic conditions. According to the Federal Reserve website, auto and light truck assemblies increased 20% in 2012.

<table> <tbody> <tr> <td colspan="5"> <p><strong>Automotive segment revenue change for 2012</strong></p> </td> </tr> <tr> <td> <p> </p> </td> <td> <p><strong>Norfolk Southern</strong></p> <p><strong>(East)</strong></p> </td> <td> <p><strong>CSX</strong></p> <p><strong>(East)</strong></p> </td> <td> <p><strong>Kansas City Southern (Midwest)</strong></p> </td> <td> <p><strong>Union Pacific</strong></p> <p><strong>(West)</strong></p> </td> </tr> <tr> <td> <p>Automotive</p> </td> <td> <p>15%</p> </td> <td> <p>23%</p> </td> <td> <p>25%</p> </td> <td> <p>20%</p> </td> </tr> </tbody> </table>

Source: Compiled from SEC documents

Increased business spending, better credit access and overall consumer confidence served as catalysts for increased automotive freight. Increased payroll taxes and cutbacks in government spending could dampen this segment for it would take money out of the pockets of the collective car buyer.

4.) Chemicals – Growth in demand for oil, plastics and industrial chemicals contributed to gains in the chemical segments (see table below). Union Pacific increased its chemical segment by 15% with petroleum contributing the most to the gain.

<table> <tbody> <tr> <td colspan="5"> <p><strong>Chemicals segment revenue change for 2012</strong></p> </td> </tr> <tr> <td> <p> </p> </td> <td> <p><strong>Norfolk Southern</strong></p> <p><strong>(East)</strong></p> </td> <td> <p><strong>CSX</strong></p> <p><strong>(East)</strong></p> </td> <td> <p><strong>Kansas City Southern</strong></p> <p><strong>(Midwest)</strong></p> </td> <td> <p><strong>Union Pacific</strong></p> <p><strong>(West)</strong></p> </td> </tr> <tr> <td> <p>Chemicals</p> </td> <td> <p>7%</p> </td> <td> <p>5%</p> </td> <td> <p>7%</p> </td> <td> <p>15%</p> </td> </tr> </tbody> </table>

Source: Compiled from Sec documents

This segment will continue to benefit from ever increasing global demand for energy and the drive for domestic energy production. Union Pacific operates near oil producing areas in the U.S. giving it an extra advantage.

5.) Industrial Products – Industrial products also served Union Pacific and Kansas City Southern well with 10% growth rates. The housing recovery contributed highly to this segment with a boost in lumber and rock freight. If the housing recovery sustains itself, this segment will continue to benefit railroads.

<table> <tbody> <tr> <td colspan="5"> <p><strong>Industrial products segment revenue change for 2012</strong></p> </td> </tr> <tr> <td> <p> </p> </td> <td> <p><strong>Norfolk Southern</strong></p> <p><strong>(East)</strong></p> </td> <td> <p><strong>CSX</strong></p> <p><strong>(East)</strong></p> </td> <td> <p><strong>Kansas City Southern</strong></p> <p><strong>(Midwest)</strong></p> </td> <td> <p><strong>Union Pacific</strong></p> <p><strong>(West)</strong></p> </td> </tr> <tr> <td> <p>Industrial Products</p> </td> <td> <p>6%*</p> </td> <td> <p>3%**</p> </td> <td> <p>10%</p> </td> <td> <p>10%</p> </td> </tr> </tbody> </table>

*Includes Paper, clay, metals and forest products
**Includes metals and forest products
Source: Compiled from SEC documents

6.) Intermodal – Railroads compete in the vital logistical market of moving goods from ports and distributors into the hands of retailers. The intermodal segment increased by double digits for all the railroads except Norfolk Southern (see table below). Intermodal or box freight serves an important role in the American infrastructure and is an important avenue of growth for the railroad industry.

<table> <tbody> <tr> <td colspan="5"> <p><strong>Intermodal segment revenue change for 2012</strong></p> </td> </tr> <tr> <td> <p> </p> </td> <td> <p><strong>Norfolk Southern</strong></p> <p><strong>(East)</strong></p> </td> <td> <p><strong>CSX</strong></p> <p><strong>(East)</strong></p> <p><strong> </strong></p> </td> <td> <p><strong>Kansas City Southern</strong></p> <p><strong>(Midwest)</strong></p> <p><strong> </strong></p> </td> <td> <p><strong>Union Pacific</strong></p> <p><strong>(West)</strong></p> </td> </tr> <tr> <td> <p>Intermodal</p> </td> <td> <p>5%</p> </td> <td> <p>11%</p> </td> <td> <p>22%</p> </td> <td> <p>10%</p> </td> </tr> </tbody> </table>

Source: Compiled from SEC documents

The ability to steal business from on-the-road trucking contributes to the intermodal segment for the railroads. A shortage of skilled truckers gives railroads an advantage in accomplishing just that. Considering America imports more goods than any other country, railroads will continue to gain from this trend assuming they can maintain the leg up over other modes of transportation.

Which company stands out?

The best railroad will possess the most diverse form of freight as different segments of the economy wax and wane. For example, if chemicals go into a slump you wouldn’t want a railroad to derive 80% of its revenue from chemical freight. The same goes for coal, automotive, etc. Here’s how the railroads breakdown by 2012 revenue.

Looking at the pie charts below, Union Pacific wins the contest for diversity; however, its automotive segment leans a little to the light side with only 9%. Industrial products make up a disproportionate percentage of Kansas City Southern’s revenue. Coal tips the balance for CSX and Norfolk Southern comprising 27% and 26% of total revenue for those two companies which, consequently, gave the worst numbers this past quarter due to weakness in demand.

<img src="/media/images/user_12973/article-110-unp-and-ksu-pie-chart-iii_large.jpg" />

Source: Union Pacific data compiled from SEC documents

Source: Kansas City Southern data compiled from SEC documents

<img src="/media/images/user_12973/article-110-nsc-and-csx-pie-chart-i_large.jpg" />

Source: Norfolk Southern data compiled from SEC documents

Source: CSX data compiled from SEC documents

Looking forward

To sum it up, continued softness in coal will continue to drag on the rail industry as a whole. If drought conditions continue, the agricultural segment will also suffer. The continued drive for domestic energy production and global appetite for energy will drive the chemical segments. The housing recovery will boost lumber and rock freight. Imports and on-the-road driver shortages will benefit railroads. Union Pacific stands out on top as it possesses even exposure to all types of freight.


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