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Railroads’ Brakes Beginning to Screech

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Like a snowball rolled from an alpine peak, evidence is gathering at breakneck speed suggesting a brisk reversal of fortune on tap for North America's beloved railway stocks.

The last of the major rail haulers to report fourth-quarter earnings, Norfolk Southern (NYSE: NSC  ) certainly appears to be right on track. The company delivered record net income of $452 million, a 13% increase from the prior year, and enough to beat analyst expectations. Robust profits have certainly characterized the sector for this round of earnings, but I believe forward-looking Fools will share my concerns for subsequent periods.

Let's take a moment to recap. Canadian National Railway (NYSE: CNI  ) beat estimates with a 20% increase to adjusted earnings. Burlington Northern Santa Fe (NYSE: BNI  ) reported a 23% boost in earnings per share, and CSX (NYSE: CSX  ) grew adjusted earnings 6% over the prior year. If all we looked at were earnings numbers, Fools might think Warren Buffett had struck pay dirt already with Berkshire Hathaway’s (NYSE: BRK-B  ) increased stake in Burlington Northern. Within each of those earnings releases, however, I highlighted a common set of variables that point to a dramatically different scenario developing like an avalanche.

The pitfalls ahead for railways are entirely macroeconomic in nature, and in no way reflect upon what are some extremely well-run companies (Norfolk Southern improved its operating ratio by 450 basis points to 67.5% in the fourth quarter). To date, rail companies were able to employ a number of lifelines to delay the impacts of an accelerating economic contraction. Lagging fuel surcharges kept prices relatively strong even as volumes declined. Strength in coal shipments has served to offset some horrid declines in freight volumes for automobiles, construction materials, and even grain. 

Those lifelines, however, have now been used. Fuel prices can scarcely drop further, and production cuts among coal miners will exacerbate volume declines that have reached troubling proportions over recent weeks. According to industry data, Norfolk Southern's overall freight volumes have averaged roughly 18% below prior-year levels over the past four weeks.

I believe that resumption of coal demand will ultimately toss another lifeline to rail stocks, and Norfolk Southern is positioned well with rail networks surrounding the prolific Appalachian region where companies like CONSOL Energy (NYSE: CNX  ) and Massey Energy (NYSE: MEE  ) operate. In the meantime, however, I think Fools would do well to step off the trains for a quarter or two.

Further Foolishness:

Some 880 Motley Fool CAPS members, including 248 All-Stars, expect Norfolk Southern to outperform the S&P 500. In all, the CAPS community has shared its collective insight on 35 "road and rail" companies. Join the free CAPS community today and share your views on how the rail industry will fare throughout the current financial crisis.

Fool contributor Christopher Barker captains yachts and writes about stocks. He can be found blogging actively and acting Foolishly within the CAPS community under the username TMFSinchiruna. He owns shares of Massey Energy. Berkshire Hathaway is a Motley Fool Inside Value and a Motley Fool Stock Advisor pick. Canadian National Railway is also a Motley Fool Stock Advisor selection. The Fool owns shares of Berkshire Hathaway. The Motley Fool's disclosure policy can climb any mountain.

Read/Post Comments (6) | Recommend This Article (27)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 30, 2009, at 2:56 AM, fredhiller wrote:

    Well the solution strategy wise, will be for rail carriers to broaden their market base and bolster their distribution infrastructure so as to ensure that more than bulk, large scale commodities will be their lifeline...

    This would be a wise move for Norfolk Southern as the future of the coal industry is uncertain as civil society and policymakers are moving to encourage the replacement of a growing share of that market activity, especially with the coal ash problems that led to public health concerns... (a big no-no as things are changing direction)

    Does anyone have any figures on freight volumes for other rail distributors? It seems a bit unwise to be giving this advice on the basis of one figure for one company. I would sense that, because rail distribution is a difficult industry to consolidate easily, that diverse investments in the best managed companies would be advisable. Look at what they are shipping, as that, as mentioned above, is the lifeline of any rail company. Are the bulk of contracts economically sustainable? Or are they in industries that are buckling under the weight of a transitioning economy?

    Most importantly, the (re)budding rail industry needs to move to secure conducive policy to bolster their operations. Currently the truck lobby is still very powerful, so as soon as the rail can move in to strongly complement that influence, the trucking industry's favor will persist in the capitol

    What qualifies me to talk about this? My mother used to be a bigshot saleswoman for Burlington Northern (Now Burlington Northern Santa Fe) during the waning years of its reign over distribution in this country. Brokering billion dollar deals with powerful companies, she saw the direction the industry was moving in as trucking distribution technology, a growing lobby, and conducive policy aided and abetted the growth of the trucking industry. I have heard about it time and time again over the years.

    Not that the trucking industry will collapse with the almost unfair competition in efficiency rail offers. For regional distribution they will have plenty of business to do, and can work with their brothers in rail to attain good, solid contracts in the future of our countrys distribution.

    God Bless America's Railways

    Fred Hiller

  • Report this Comment On January 30, 2009, at 9:25 AM, ronbeasley wrote:

    Let's see...Warren Buffett, perhaps the best investor in the country, is buying Burlington stock hand over fist, but Christopher Barker (who?) says to avoid it because earnings will be hampered for a few months. Who to follow, who to follow...tough decision.

  • Report this Comment On January 30, 2009, at 10:28 AM, linuxman4001 wrote:

    Agreed. Sensible investors dont trade stocks we buy businesses. And many of the railroads NSC, BNI in particular are good sound long term holdings. My money is with Mr. Buffett.

  • Report this Comment On January 31, 2009, at 8:16 PM, lalbright5 wrote:

    Buy!!!! You sound like scared rabbits. At 35-42 dollars a share, Norfolk Southern is a no brainer to be buying...

  • Report this Comment On February 05, 2009, at 12:30 PM, Slipswitch wrote:

    Look up "Progressive Railroading" for statistics on volumes. Or the individual RR websites. There are too many power plants using coal for demand to die overnight. It is very simple for RR's to transport, as it doesn't have to be sorted.

    There are two sides to the Obama coin: restrictions on coal, yet encouraging and funding freight RR use.

  • Report this Comment On February 05, 2009, at 4:25 PM, XMFSinchiruna wrote:

    I just call it as I see it, Fools. :) Hopefully, recent industry data will prove to have been an anomalous dip, but as of the date of this article's publication, the data were horrific. Looking at the same site today, data seems to be recovering somewhat, but these are still enormous percent declines over prior year numbers.

    Also, I tried to make clear that I consider these to be high quality companies with terrific long-term prospects. I just happen to think that that the recent rate of decline, along with the lost lifelines I outlined, was not yet priced into the stocks ... which suggested to me that better entry levels may yet be looming. For the truly long-term value investor, the precise entry point may be far less of a concern.

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