Tickers in this Article: UNP, NSC, CSX, BRK.A
The month-by-month rail data provided by the Association of American Railroads through the monthly Rail Time Indicators publication has always been something to take with a grain of salt - one month doesn't make a trend and no trailing data report can ever tell an investor what's about to happen. All of that said, data is now flashing a strong yellow and investors in transportation stocks, not to mention industrial and resource stocks, should approach these companies with some caution. Investopedia Broker Guides: Enhance your trading with the tools from today's top online brokers.

Data Continues to Weaken
Year-to-date trends haven't been all that robust among Class 1 United States railroads, and July's data showed continued erosion. Year-on-year carloads dropped 0.7% as reported, which sounds at least superficially better than the -1.3% number for June. Excluding coal, though, traffic was flat (up 2.2% in June) and excluding coal and grain moves the carload number to 1.4% growth (versus 4.2% in June). On a sequential basis, traffic was basically flat with June.

Part of what concerns me about the rail data is that there are fewer and fewer horses pulling the wagon. While 12 categories showed carload growth last year, there were just eight positive categories in July - down one from June and the lowest since May of 2011. So, although the strong growth in petroleum and automobile car traffic is helpful (and the growth in lumber/wood is encouraging), the declines in coal, chemicals, grain, scrap metal and other categories are a concern.

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King Coal Getting a Boost from Weather?
Coal traffic was down 1.7% in July, but the trends in coal shipments seem to be getting better (or least have stopped getting worse). Some of this "improvement" has to be viewed in the context of just how bad year-to-date performance has been; prior to July, there were five straight months of greater than 5% declines and four of five months were down more than 10%.

Given that there are still many utilities that operate coal plants, there's going to be some baseline level of shipments in any particular month. What's more, brutally hot weather in much of the country is helping - utilities have gone about as far as they can in switching to natural gas and any incremental electricity demand (to run all of those air conditioners) has to be met largely with coal-fired generation. This is not exactly great news for Arch Coal (NYSE:ACI), Cloud Peak (NYSE:CLD) or Peabody (NYSE:BTU), but it does point to at least the possibility of some stabilization.

Can Expense Control and Pricing Keep Pushing Profit Growth?
By and large, the second quarter was a decent one for Union Pacific (NYSE:UNP), CSX (NYSE:CSX), Norfolk Southern (NYSE:NSC) and Berkshire Hathaway's (NYSE:BRK.A, BRK.B) BNSF. With data coming out every month on volume, there weren't many surprises here, but the rails by and large succeeded in surpassing expectations on pricing and/or expense control.

The question is how much further the companies can go. Rail carriage enjoys considerable advantages over truck carriage, but chemical, timber and car companies will eventually start drawing lines in the sand over pricing. Likewise, the rails have used automation and better organization and planning to improve operating performance and reduce costs, but many of these companies seem to be approaching near-term peaks in terms of margins.

The Bottom Line
There are certainly some positive rebuttals or spins for the railroad sector. For starters, this year's traffic pattern resembles last year's and that year turned out OK. Second, while there have been a few stumbles in the intermodal sector ((including J.B. Hunt (Nasdaq:JBHT)), the long-term growth and margin potential here are still substantial for the Class 1 operators. It's also true that while valuations are not at trough levels, neither are they at peaks and these companies have generally been showing better operating performance than expected.

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With the number of industrial groups showing carload traffic growth shrinking, investors can't be blithely confident about operating conditions today. That said, most industrial companies continue to report that North America is a source of strength and if expectations for a late 2012 recovery in global growth prove accurate, rails may yet end the year on a high note.

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

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