Betting on a breakthrough: the signs are strong that 2004 will be a turnaround year for the railroads—provided they are able to cope with the increased business the market wants to give them - Railroading in 2004 - Cover Story

Railway Age, Dec, 2003 by William C. Vantuono

2003 has been a tough year for the industry, one in which, during a stagnant economy, railroads dealt with mostly-flat traffic levels (except for intermodal, the year's one bright spot) and higher costs and operating ratios, not to mention a few service problems. Suppliers are still hurting, though freight car deliveries are much healthier, following a painful down cycle.

2004 looks to be a better year. As the economy recovers, railroad traffic levels are expected to rise with it. Following modest increases in capital spending in the latter half of this year, some Class I's plan to follow through for 2004 with capital programs that are, at worst, flat compared to 2003, or slightly higher. Suppliers are anticipating an improved business climate, though they're far from being ready to declare a celebration (sidebar, p. 26). Everything hinges upon the degree to which the economy and railroad traffic levels improve.

When posed a question by Railway Age about what opportunities lie ahead in 2004, and what railroads must do to take advantage of them, independent Wall Street analyst Tony Hatch had this to say:

"The first challenge for the major railroads will be to correct the service glitches that appear to have affected the North American system so that they can take advantage of what could be a breakthrough year. 2004 could be a year when intermodal and merchandise carload takes its performance and share to the next level. The truckers Face hours of service rules, consistently high operating expenses, and tight capacity. Their rates have to go up, widening the price gap to rail. Rail intermodal and merchandise traffic has grown pretty, well over the period of service recovery and alliance building, and it should really explode in 2004. And what really could be exciting is that it should be a very good year for bulk commodities, especially grain. So, after the railroad service metrics pick up, the real challenge for the major carriers will be to take advantage of the situation they have painstakingly placed themselves in, and profitably (returns on capital never stray far from investor's concerns) take the share the market wants to give them."

Financial health? First Call, a data gathering service that collects estimates from all the major Wall Street firms, offers these estimates of" "long term" (two to five years, a long time for the financial community) railroad earnings-per share growth: Union Pacific (which recently increased its common stock dividend by 30%, to 30 cents per share), 13%; BNSF, 9%; Norfolk Southern, 10%; CSX, 12%; CN, 12%; Canadian Pacific, 10%; and Kansas CW Southern, 15%, for an industry average of 11%.

The railroad outlook tends to be more conservative. "This is not a simple economic recovery," Norfolk Southern's David Goode recently told Wall Street analysts. "It is not like somebody turning on a light switch. There are pluses and minuses, and our strategy is not to think that we can necessarily influence the course of the business. Our strategy is to be nimble enough to try to be available. We're not looking for a snap-your-fingers and the economy is dramatically better in the fourth quarter or any time next year. What we think we are seeing are signs of a steady improvement. But for every pins, you've got to work through a minus."

If 2004 does offer growth opportunities as expected, it will be a breakthrough year only if the railroads are able to cope with the business. They'll have to put enough equipment and enough crews on their networks to avoid the embarrassing traffic jams and service disruptions that occurred in 2003. There's been movement in this direction. For example, freight car deliveries are currently running nearly double the pace of 2002. And Union Pacific plans to hire as many as 3,000 operating workers in 2004, building on the 2,000 it has already added.

How do the Class I's see 2004? What do their spending plans look like? Here's what they told Railway Age:

Dick Davidson, CEO, Union Pacific Railroad: "It's certainly encouraging to see the economy pick up steam after many months of sluggishness. Yet we at UP still remain cautious as we look ahead to 2004. The worst is behind us, and we want to believe that across-the board economic growth lies ahead. There's already plenty, of cause for optimism. On our railroad, housing and highway construction materials are on the upswing, intermodal traffic is strengthening, and there is strong demand for coal and agricultural products. But at the same time, we still await consistent growth in economically sensitive sectors, such as chemicals--particularly plastics--and motor vehicles, among others.

"On the expense side, we continue to keep close watch on unpredictable diesel fuel prices, which have sharply boosted our costs over the past two years. While not final, our capital program for 2004 involves spending about $2 billion, the same general level as in the past few years. We believe that consistent investment in our railroad, no matter the economic climate, makes the best business sense."