This year is shaping up to be an attractive one for railroads. Regulators and customers are rewarding trains for their superior environmental profile just as railroad companies are reinvesting heavily in factors that drive efficiency and boost their bottom line. Investors would be wise to get on board.
Improving the ride
Standard & Poor's reported at the end of March that it expects the railroad industry to spend $13 billion on infrastructure improvements in 2012. Much of the money will go toward track and facility upgrades, but S&P expects a significant portion to go toward developing intermodal capacity, in which various modes of transport -- truck, rail, and ship -- move large freight containers.
The increasing use of intermodal transport has been a key storyline in this industry because of better logistics management by railroads, lower fuel costs, and highway congestion. On top of the efficiency improvements, the Rail Safety Improvement Act of 2008 helped spur the installation of positive train control systems by major carriers, which increases the stability and safety of railroad transportation.
All this points to a bright outlook for freight rail operators and intermodal transport in general. As trucking becomes less attractive for long-haul routes, customers are turning to rail transport because of its efficiencies and environmental benefits. Consider, for instance, that a 2009 report by the Federal Railroad Administration noted that the rail-truck fuel efficiency ratio ranges from 1.9 to 5.5, indicating greater fuel efficiency in all 23 instances of the study. This study evaluated each route in terms of ton-miles per gallon of fuel, and the ratio could be even greater given the recent spike in fuel prices.
Furthermore, according to the EPA, intermodal reduces fuel use and greenhouse gas emissions by 65% compared to trucking for shipments farther than 1,000 miles. In all likelihood, these trends provide a strong argument for greater use of intermodal transport with trucking providing the ideal flexibility and railroads providing a cost-effective option for long-haul routes.
Looking further down the track, railroad companies have noticed that a greener approach not only enhances their image, but also attracts more customers. In September 2011, Norfolk Southern (NYSE: NSC ) and GE Transportation -- a unit of General Electric (NYSE: GE ) -- sponsored the first Railroad Sustainability Symposium, intended to drive continuous improvement of freight rail's environmental profile. All Class I railroads sent attendees, and the event was so successful that the sponsors intend to move full steam ahead with an annual event.
A federal mandate first forced the railroad industry to consider its environmental impact, but sustainability is now something that rail operators consistently recognize as good business. Recent efforts have tended to focus on fleet upgrades to improve fuel efficiency and reduce emissions, but there is now a drive to pursue a more holistic approach to managing environmental effects across all operations.
Midnight train to... Norfolk? Canada?
Industry executives say that much of the push toward greener operations is coming directly from customers, as well as from shareholders and company employees. Norfolk Southern is pursuing a reforestation partnership to help replace trees that it felled as part of track laying. Not only is this good for the environment, but the company will also reap rewards in the form of carbon-offset credits that can be sold. Canadian National (NYSE: CNI ) , the only Class I railroad listed on the Dow Jones Sustainability Indexes, is pouring money into energy-efficient intermodal equipment. CSX (NYSE: CSX ) is working hard to reduce its carbon footprint, and Union Pacific (NYSE: UNP ) is engaging its motivated workforce in companywide environmental initiatives.
A rising tide lifts all... trains?
All of these factors could benefit the railroad industry, but the savvy investor will analyze which company possesses the strongest fundamentals. Look at gross margins to gauge management's ability to manage costs, return on equity to assess investment strategies, and debt levels to avoid overleveraged operators.
Overall, the recovery of the broader economy has lifted the prospects of all major American railroads. In fact, the four largest publicly traded carriers have experienced an average share price return of 195% over the past three years. Still, some stocks have performed even better, including the one unveiled in our special free report "The Motley Fool's Top Stock for 2012." Shares in this company have skyrocketed more than 280% in that same time frame. Click here to learn more about this promising company.