Danger: Step Away From the Railroad Tracks

Spring fever has reached a pandemic stage this year, spreading wildly among investors to fuel a most unsustainable equity rally. To prevent the fever from progressing into fiscal illness, I recommend a strong dose of reality.

As a Fool tracking scores of bellwether companies from steelmakers to shippers, I receive a daily dose of reality that suggests danger on the horizon for those swept up in this understandable outbreak of optimism. I derive no pleasure in sounding the alarm, but do so out of concern for my fellow Fools.

CSX (NYSE: CSX  ) opens earnings season for the railroads, and this week delivered a 23% decline in comparable net earnings to $246 million. Both revenues and overall freight volumes declined 17%. In an eerie sign of the times, the company pointed to "significant weakness in industrial production, housing starts, and consumer spending, as well as in the agriculture and energy sectors." That's a pretty inclusive list, essentially encompassing the entire gamut of businesses on which the railroads rely.

Looking forward, CSX sees sustained double-digit declines in freight volumes amid plummeting demand, increased competition from the trucking sector, and even deterioration in demand for coal. Coal, which recently gained significance to railroads as one of the least-impaired among freight categories, is also facing a reality check. 

The emerging dichotomy of coal demand -- weak in North America but stronger in Asia -- is confirmed by additional production cuts by miners Peabody Energy (NYSE: BTU  ) and Cliffs Natural Resources (NYSE: CLF  ) . Parallel weakness among American steelmakers, operating below 45% of capacity, offers further corroboration. While investors delight in a rally fed by spring fever, the core businesses that drive the railroad sector have caught the flu.

In January, when railroads last reported earnings, I warned of challenges developing with the industry; and predicted that investors would find more favorable entry points. Every stock I mentioned -- Burlington Northern Santa Fe (NYSE: BNI  ) , Norfolk Southern (NYSE: NSC  ) , Canadian National Railway (NYSE: CNI  ) , Union Pacific (NYSE: UNP  ) , and CSX -- soon derailed before carving 52-week lows precisely on March 9, 2009. 

Something magical happened to railroad stocks on that date, sparking a 30% to 50% rally for the group. What happened on March 9? The Dow found a temporary bottom at a 12-year low. However, getting in now on a rally that I see as unsustainable is one case of spring fever you do not want to catch.

Further Foolishness:

More than 1,500 Motley Fool CAPS members, including 316 All-Stars, expect CSX 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 has never hopped a freight train, but he thinks it would be a fun place to learn the harmonica. He can be found blogging actively and acting Foolishly within the CAPS community under the username TMFSinchiruna. He owns shares of Cliffs Natural Resources and Peabody Energy. Canadian National Railway is a Motley Fool Stock Advisor selection. Try any of our Foolish newsletters today, free for 30 days. The Motley Fool has a disclosure policy named Thomas, from the island of Sodor.


Read/Post Comments (3) | Recommend This Article (17)

Comments from our Foolish Readers

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 April 16, 2009, at 6:22 PM, XMFSinchiruna wrote:

    Please do share your comments here, but I have also posted additional discussion of the topic to my CAPS blog:

    http://caps.fool.com/Blogs/ViewPost.aspx?bpid=181718&t=0...

  • Report this Comment On April 17, 2009, at 11:09 AM, HORSPLA wrote:

    A little confused. Some conflicting advice for BNI investors posted less than two hours apart.

    http://www.fool.com/investing/general/2009/04/16/5-star-stoc...

    Is there some clarification that is needed here?

  • Report this Comment On April 17, 2009, at 11:20 AM, XMFSinchiruna wrote:

    HORSPLA,

    I'll be happy to offer some clarification. The article you linked to merely points out that additional CAPS members have recently become increasingly bullish on BNI, accounting for the switch from 4 to 5 stars. This is not advice, but rather a statistical observation regarding the sentiment of the CAPS community.

    In my opinion, this bullishness is indicative of the spring fever rally now ongoing, and I encourage you to consider the evidence presented above while conducting your own due diligence on the railroad sector.

    Thank you for reading and commenting. Fool on!

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