April's 2012 rail data looks like more than a little bit of history repeated. While the healths of the railroads and the economy have generally been pretty closely correlated, some of that linkage is breaking down. With coal demand plunging, but most other core industrial categories doing well, this may be a case where rails struggle to replace the high-margin coal revenue while the rest of the economy continues to grow.
Investopedia Broker Guides: Enhance your trading with the tools from today's top online brokers.
Another Weak Month
According to Rail Time Indicators, a publication of the Association of American Railroads, United States rail traffic dropped 5.5% from last year's level and 2% from March. Intermodal traffic was up 3.6% from last year, while the month-on-month performance saw 0.3% growth. Of the 20 major categories, 11 had positive carload traffic in April (versus 13 a year ago and 12 last month).
Once again, though, traffic trends were dominated by the volatile (but voluminous) coal and grain numbers. Coal traffic plunged more than 16% this month, while grain was even worse (down 17%). Scrub those out and the ex-coal/ex-grain traffic actually increased almost 7% for the month - a pretty good sign for the economy as a whole.
SEE: A Primer On The Railroad Sector
No Joy in the Coal Mines
Clearly the current trends in coal are having a big impact on the sector, as the combination of a warm winter, low natural gas prices and new environmental rules all combine to pressure coal demand. This is a serious matter for Norfolk Southern (NYSE:NSC), CSX (NYSE:CSX) and Berkshire Hathaway's (NYSE:BRK.A) Burlington Northern, as all of these companies get a substantial amount of their revenue (25%+) and operating income from hauling coal.
If there's good news, it's that most of the Eastern utilities that can switch to natural gas have already done so. Moreover, there's not as much natural gas-fired capacity in the Midwest, so those utilities will continue to need coal. If this happens to be an exceptionally warm summer and electricity demand spikes, those coal inventories might decline and demand could pick up. Nevertheless, this is going to be a lousy year for coal transport.
SEE: Understanding The Income Statement
There Are Some Alternatives
While coal is a major line item for Norfolk Southern, CSX and BNSF, it's not nearly as significant for Union Pacific (NYSE:UNP), and it's frankly a small part of the overall picture Canadian Pacific (NYSE:CP), Canadian National (NYSE:CNI), Kansas City Southern (NYSE:KSU) and Genesee & Wyoming (NYSE:GWR).
Kansas City Southern would seem to be an especially interesting railroad today. While it has some vulnerability to the grain sector, record corn plantings suggest that there should be heavy rail demand later in the year as that corn moves to silos and other customers. More to the point, it has good industrial exposure and should continue to benefit from the ongoing traffic recovery without that worrisome exposure to coal.
SEE: Earning Forecasts: A Primer
The Bottom Line
It's not too surprising, then, that Kansas City Southern, Canadian Pacific and Canadian National are all near 52-week highs and sporting double-digit enterprise multiples (though CN is technically at 9.9 times as of this writing).
By comparison, CSX would seem to be the cheapest of the major Class 1 comparables. While investors may be tempted to think CSX has been overly punished, a quick look at the earnings estimates suggests only moderate downward revisions so far (though the March quarter was actually pretty solid).
The good news for rail investors is that there wouldn't seem to be much room for coal traffic to get worse, while industrial demand has remained fairly strong. Though the health of Europe and China play directly into that lucrative intermodal growth, I wouldn't be in a hurry to flee this sector yet.
Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!
At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.
Mutual Funds & ETFsLearn about four of the best-performing exchange-traded funds, or ETFs, that offer investors exposure to the Asia-Pacific region.
Mutual Funds & ETFsLearn about the top three exchange-traded funds (ETFs) that invest in sovereign and corporate bonds issued by developed countries, including Japan.
Mutual Funds & ETFsLearn about arbitrage funds and how this type of investment generates profits by taking advantage of price differentials between the cash and futures markets.
SavingsIf you have some financial know-how, you don’t have to hire someone to advise you on investments. This tutorial will help you set goals – and get started.
Investing NewsWill Ferrari's shares move fast off the line only to sputter later?
Investing BasicsUnderstand the hedge fund industry and why it has grown exponentially since 1995. Learn about the top six reasons why the industry underperforms.
Investing NewsShares of Glencore International, a leading multinational commodities and mining company, jumped by around 15% on London Stock Exchange, after the shares had gained about 71% earlier on the Hong ...
InvestingCommodity prices have been heading lower for more than four years, being the worst performing asset class of 2015 with more losses in cyclical commodities.
Mutual Funds & ETFsThese three transportation funds attract the majority of sector volume.
Stock AnalysisHere are five stocks that pay safe dividends and should be at least somewhat resilient to a bear market.
Mutual funds can invest in initial public offerings (IPOS). However, most mutual funds have bylaws that prevent them from ... Read Full Answer >>
When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
The rise of index trading may increase the overall vulnerability of the stock market due to increased correlations between ... Read Full Answer >>
If an investment fund has a high turnover ratio, it indicates it replaces most or all of its holdings over a one-year period. ... Read Full Answer >>