Railroads and the economy

Railway Age, Feb, 2008

The U.S. economy may be sliding into a recession, but so tar the railroads have bucked that trend, posting strong fourth-quarter and full-year 2007 results. Late last month, as the Dow Jones Industrial Average took a disconcerting roller coaster ride and the Federal Reserve Board slashed the prime rate by three-quarters of a point, Bear Stearns upgraded the railroads sector to "overweight" from "market weight," saying it is "increasingly bullish that transportation companies will lead the U.S. economy out of the downturn."

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Bear Stearns upgraded CN, BNSF, and Union Pacific from "peer perform" to "outperform." UP, it said, is best positioned for volume growth over the near and longer term and should benefit from continued strong demand for Powder River Basin coal as well as corn, both for export and ethanol production. CN could lead the railroads in volume growth because of growing business into and out of the port at Prince Rupert, and construction materials and chemicals demand primarily from Alberta's growing oil sand's region (cover story, p. 16). BNSF could show the most earnings-per-share leverage due to an increase in volumes.

Several Class I financials supported Bear Stearns' assessment. Saying it's defying "economic headwinds," Norfolk Southern posted record fourth-quarter 2007 earnings of $399 million, or $1.02 a share, exceeding year-earlier earnings earlier by 4% and easily topping the Wall Street per-share forecast of 91 cents. "While the economic picture remains uncertain, we are optimistic about our prospects for 2008 and beyond," said CEO Wick Moorman.

NS also set a fourth-quarter record of $4.5 billion in operating revenue, despite a 3% decline in traffic volume caused by flat merchandise traffic and lower intermodal and coal volumes. Railway operating income climbed 12% to $686 million for the quarter and the operating ratio improved by 1.5 percentage points to 72.0%.

CSX, which announced its results as the stock market gained strength from the Fed's rate-cut, posted fourth-quarter 2007 net income of $365 million, compared with $347 million in the 2006 quarter. Excluding special items, earnings rose to 85 cents per share from 57 cents, exceeding the Wall Street consensus estimate of 64 cents. Higher freight rates and increased productivity helped offset soaring fuel prices and weaker traffic.

"We still see growth in the economy this year," CSX CEO Michael Ward said. "It will be slower growth, but I don't think we'll see a recession." CSX said its Surface Transportation businesses posted record fourth-quarter operating income of $609 million vs. $508 million in the 2006 period. Full-year revenue topped $10 billion and the operating ratio was the best in a decade.

Despite disruptive winter weather and all-time-high fuel prices, Union Pacific was able to post record fourth-quarter 2007 earnings of $491 million or $1.86 per share, beating the Wall Street forecast of $1.76. Strong pricing and improved productivity through operational efficiency made the difference, said CEO Jim Young. For the full year, net income increased 16% to $1.86 billion and return on invested capital grew to 8.7%. "Overall, we remain optimistic that our superior franchise will enable us to overcome economic weakness and post another record year in 2008," said Young. For the full year, UP's operating ratio improved 2.2 points to 79.3% from 81.5% in 2006.

CN "faced strong headwinds in 2007, but we turned in a solid performance for both the quarter and the year," said CEO E. Hunter Harrison. For the full year, CN net income was C$2.16 billion, on revenue of C$7.90 billion, compared with 2006 net income of C$2.09 billion, on revenue of C$7.93 billion. CN said operating expenses increased 2% due to increased fuel costs and equipment rents. The full-year operating ratio rose about two points to 63.6%, but it was still the industry's lowest.