High Oil Prices Benefit This Niche Industry

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When oil prices zoom skyward, investors tend to flock toward oil stocks. Of course, that's often the worst time to do so -- the big names react quickly to oil price gyrations. But there are plenty of other, more overlooked industries that benefit from higher oil prices. One of the most overlooked is the very niche intermodal transportation industry.

Intermodal transportation companies (IMCs for short) act as middlemen between the companies shipping stuff and the rail and trucking companies that actually transport the stuff. And that stuff we are talking about is big freight. If you want to send a holiday gift to your brother, you use FedEx or United Parcel Service. If you need to get 500 automobile frames from L.A. to Detroit -- picking up 500 drivetrains in Wichita on the way -- to arrive between 4:00 and 4:30 p.m. on Thursday, you call an IMC.

Intermodal transporters have that name because they transport their freight intermodally -- that is, using more than one mode of transportation. The most common combination is rail and truck, but some IMCs may place cargo on steamships as well, usually to bring in international freight. Most IMCs don't own any of the transportation infrastructure they use. Instead, they have relationships with railroads and trucking companies to use, respectively, their rail networks and trucks. Generally, IMCs provide their own containers, which are moved directly from railcars to truckbeds and back, but they mostly lease these as well, and then sub-lease them to the railroads and trucking companies when they aren't in use.

IMCs benefit from higher oil prices for a simple reason: Rail transportation requires less fuel, and is therefore cheaper, than trucking. Trucking is faster, though, so there is a trade-off. The higher oil prices soar, the more tradeoffs skew in the favor of IMCs.

A middleman that won't be cut out
This arrangement sounds great for the IMCs -- they get access to massive networks of transportation networks without the hassle of actually paying for any of it. But why do the trucking companies -- and, more importantly, the powerful large railroads, let them get away with this?

It's a matter of differing objectives. Railroads have monstrous fixed assets and the accompanying fixed costs, not least of which are those that come with powerful labor unions. The rail companies' primary focus is maximizing the utilization of those assets. For that reason, they want large, predictable customers. They focus on bulky raw materials like coal and timber. They do not want to be highly customer-facing; the expense and time-intensity of those relationships combined with unpredictable customer transport requirements spell a nightmare for the railroads. But they view IMCs -- which take on those customer-facing roles and aggregate many smaller, less regular shipments into larger, more predictable loads -- as one large customer with whom the cost to deal is low.

IMCs offer railroads another benefit -- containers. Railroads, with their focus on asset utilization, are loath to let their containers leave their networks. (Steamships, which usually don't allow their containers to travel more than 40 miles from port, are the same way). But few end customers are located within a stone's throw of major rail hubs, and that cargo needs to get to them somehow. IMCs offer a solution -- they provide their own containers, which they move from railcars to truckbeds to get the freight from customer to rail and vice versa.

The big players are here to stay
The intermodal industry is dominated by J.B. Hunt (Nasdaq: JBHT  ) and Hub Group (Nasdaq: HUBG  ) , which together command 47% of the market. After those two, there is a long tail of small players, most of which are, in my opinion, doomed to either stay small or slowly go out of business. The intermodal business depends crucially on scale. To be successful as an IMC, you need relationships with major railroads. To secure relationships with the major railroads, you need large amounts of freight. This cat-chasing-its-tail scenario has been reinforced in recent years as the number of major North American rail companies has steadily shrunk amid industry consolidation. Where there were upward of 25 major rail companies 30 years ago, today there are basically five:

Railroad

Miles of Track

Burlington Northern Santa Fe 50,000
Union Pacific (NYSE: UNP  ) 31,953
CSX (NYSE: CSX  ) 21,000
Canadian National Railway 20,600
Norfolk Southern 20,000

Source: Capital IQ.

Bigger railroads demand bigger customers, and few intermodal companies outside those two leaders have the scale. With these barriers to entry, the incumbents have a strong position in their market.

There is one small IMC worth noting: Pacer International (Nasdaq: PACR  ) . Though tiny (the company's $160 million market cap qualifies it as a micro-cap), this intermodal company has relationships with most of the major railroads and has access to more freight containers than either J.B. Hunt or Hub Group. (You can see my full take on Pacer.)

Look deeper
Next time you're thinking about investing to take advantage of some trends -- like higher oil prices -- take a step back. The companies directly associated with the trend are the most obvious candidates, but they are also usually the ones garnering the most attention and, accordingly, expensive stocks. But all trends send off ripples, so look further out and you might find interesting companies and sectors -- like the intermodal transportation industry -- that can make for great investments.

Alex Pape has no positions in the stocks mentioned above. Follow Alex on Twitter.The Motley Fool owns shares of UPS, Pacer International, and FedEx. Motley Fool newsletter services have recommended buying shares of FedEx. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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