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Don't Buy These Railroad Stocks Until You Read This

As a business, it's difficult to succeed when you have three of the most powerful forces on earth working against you -- weather, government, and unions.

And that's just what Canadian National (NYSE: CNI  ) and Canadian Pacific (NYSE: CP  ) have been dealing with during the first three months of 2014. Let's take a close look at what they've been up against and consider how it may affect their first-quarter results. 

Brutal weather
CN blamed December's extreme cold weather for a surprising deterioration in its operating ratio to 63.4% during their fourth quarter. Unfortunately, the colder weather that's gripped much of Canada for the last few months is only now starting to thaw.

Take the Canadian city of Winnipeg for example. According to Environment Canada, this centrally located city experienced an average temperature of negative-six-degrees Fahrenheit in December, the second-coldest month in 120 years. Temperatures have only marginally increased since then: The average temps for January and February were 8 F and 7 F, respectively.

When it's extremely cold for extended periods of time, railways are inefficient. They run shorter trains, utilize more locomotives, and spend more money on fuel and labor. It's very likely that this frigid weather will hurt both CN and CP's first-quarter operational performance.

Frustrated government
Western Canadian farmers harvested a record 80 million tonnes of grain and oilseed last year, a crop 27% above the previous 2008-2009 record and 37% above the five-year average. But much of that crop hasn't made it to market due to a lack of rail transport.

Frustrated, and with few options, Canadian farmers lobbied the Canadian government for action. And they listened. First, the Canadian government issued an emergency directive giving railways four weeks to double their grain shipments or face fines of $100,000 per day. Next, they tabled the Fair Rail for Grain Farmers Act, which includes a minimum volume requirement for CN and CP of 1 million tonnes per week, as well as an increase in the inter-switching limit. Currently, where a shipper is served by only one railway, it is entitled to transfer its traffic to another railway at a regulated rate if the shipper's facility is located within a 30-kilometer radius of where two railways connect. The bill would extend those limits to 160 kilometers, increasing competition and giving shippers access to alternative rail services.

Not surprisingly, CN and CP are frustrated. "This action could hit Canada's railways by opening their business to unfair poaching by U.S. railways without any reciprocity," remarked Claude Mongeau, CN's president and CEO. And CP Chief Executive Officer Hunter Harrison said that "expansion of regulated inter-switching could seriously impact Canada's competitiveness as it effectively transfers traffic that normally would move over Canadian railways and ports, to U.S. railroads and ports, potentially resulting in job losses, reduced investment, and the dampening of the Canadian economy."

In the short term, the legislation will force both CN and CP to haul more grain traffic at government-set tariffs, potentially at the expense of moving more, highly lucrative oil. And in the long term, if the legislation is passed without modification, it creates new competitive pressures for both Canadian railways.

Angry union
And just when CN thought 2014 couldn't get any more difficult, it was confronted with the reality that the Teamsters union, representing some 3,000 workers, may strike.

But just last week, the union agreed to start the arbitration process ensuring this latest contract dispute will not lead to a strike. CN expects the arbitration process toward a new collective agreement to conclude by mid-June. But given the latest challenges facing CN, and the government decree to move more grain, union leaders may feel emboldened and push for a more lucrative deal from the mediator.

Foolish bottom line
While it may be too early to determine the full extent the proposed legislation will have on CN and CP, intervention in how they optimize their network and potentially increased competition are likely to affect earnings, and how investors and analysts value their stock. Add in bad weather, and it's fair to say both Canadian railways hoped for a much better start to 2014.

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Justin K Lacey

Professional Marketer by day. Financial Analyst by night. Soon to be Certified Financial Planner (CFP). I invest every spare moment trying to understand a company's strengths, weaknesses, and where the opportunities are for future success. My aim is inform, educate and share; to spread a few “capital ideas”.

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