Rails Seem To Point To A Respectable 2013

By Stephen D. Simpson, CFA | January 08, 2013 AAA

Many analysts and investors have worried about the outlook for growth in the United States in 2013, but railroad data continues to suggest an ongoing recovery/expansion in the economy. Although it's true that the rails have enjoyed an uncommonly long stretch of good performance relative to the markets, ongoing demand growth could continue to support the sector.

Top Investment Trends For 2013: We go over a few investment trends for you to think about for 2013.

December's Data Looks Very Familiar
The Association of American Railroads reported that U.S. rail carload volume declined about 4% for the month of December relative to the prior year, while climbing more than 2% from November's level.

As has been the case for quite some time, coal and grain traffic declines were a major negative influence on the results. Coal volume declined by more than 13%, while export declines tied to this year's drought helped fuel a 14% decline in grain carload traffic. Excluding coal, carload traffic was up more than 3%, while traffic excluding coal and grain climbed 6%.

Intermodal Still Growing
Fortunately for both Union Pacific (NYSE:UNP) and Berkshire Hathaway's (NYSE:BRK.A, BRK.B) Burlington Northern, the strike that impacted the Los Angeles and Long Beach ports was relatively brief (eight days). Western intermodal volumes recovered rather quickly, and the industry as a whole saw almost 2% year-on-year growth in intermodal freight volume.

Intermodal remains a hot sub-sector, and intermodal specialists JB Hunt (Nasdaq:JBHT) and Hub Group (Nasdaq:HUBG) currently trade near their 52-week highs and at or near double-digit EV/EBITDA multiples. Assuming that China's economic situation is past the worst and Europe gets no worse (or maybe even better) in 2013, intermodal volumes should be strong again in 2013.

SEE: A Primer On The Railroad Sector

Good Signs of Life in U.S. Industry
Using the AAR's own indication of "industrial" rail traffic, this category saw 3% year-on-year growth in December - the biggest gain in about seven months. Looking closer, there was solid growth in categories such as lumber, motor vehicles and crushed stone/gravel. While metal shipments were mixed (strong scrap and coke, weak ores and primary metals) and some of the stone/gravel traffic can likely be tied to fracking demand, the point stands that there are good underlying signs in December's traffic.

That said, it's also worth noting that traffic by category was a little dicier. Of the 16 categories that the AAR reports, 12 saw positive traffic in December - down from 16 last year and 13 in the prior month. Investors may also want to consider the possibility that traffic in categories such as petroleum and chemicals may be getting a boost from the poor state of the Mississippi river, as low water levels have significantly impacted the ability to function of barge operators such as Kirby (NYSE:KEX).

Will the Good Times Keep Rolling?
The Class 1 railroads, and in particular Union Pacific, have enjoyed a very good five-year run relative to the S&P 500. Normally I would argue that that should make investors skeptical of the chances for ongoing outperformance. I'm not so sure in this case.

For starters, diesel prices have risen more than 15% over the past five years (and 160% over the past 10 years). At the same time, tighter restrictions on driver hours and higher insurance rates have increased the cost of operations for most truckers. This has given more significant cost advantages to the rail industry, not to mention the ongoing growth of intermodal traffic. While a switchover to natural gas-fueled trucks could, perhaps, reorient the cost situation in a few years that's not a near-term factor.

SEE: The 5 Most Stable Stocks

The Bottom Line
Consequently, while Union Pacific and Kansas City Southern (NYSE:KSU) may be a little pricey relative to CSX (NYSE:CSX) and Norfolk Southern (NYSE:NSC) today, the overall outlook for the railroad industry looks pretty good absent a major slip in the U.S. economy.

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

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