Over the past 10 years, railroad operator CSX's (CSX -0.06%) total annualized returns have outperformed that of the S&P 500 (16.1% vs 9.8% per year). But railroad performance appears less certain in the future, amid worries about inflation and lower shipping volume as economic growth slows, and the threat that increasingly efficient freight trucking will grab business. Recent acquisitions hint at how CSX intends to drive growth in the face of these challenges.
Expanding operations to combat lower growth
So far, the railroads have appeared resilient against rising fuel costs and supply chain disruptions. Although shipping volume declined, CSX still managed to increase Q1 revenue by 21%, with pricing gains and fuel surcharges compensating for higher costs. Reflecting confidence in the future outlook, CSX increased headcount to prevent shipping disruptions caused by labor shortages. CSX also looks to expand its footprint in New England through the acquisition of regional rail line Pan Am Railways, which should close this June.
Notably, the income statement also included trucking revenue for the first time. Last summer, CSX acquired Quality Carriers, a leading truck company providing bulk liquid chemicals transportation. Trucking accounted for about 7% of total CSX's revenue, but also about 10% of its expenses. Overall, this hurt operating efficiency for the quarter, with CSX's operating ratio – where smaller is better – increasing from 60.9% to 62.4%. However, if the Quality Carriers trucking contributions were removed, the operating ratio would have declined to an impressive 59.9%. Trucking expenses, and operating ratio, should drop over time as CSX streamlines its process.
Integrated rail-to-highway transport offering
CSX believes that the comprehensive transportation service will extend its network in the chemical transportation industry. While chief competitor Norfolk Southern (NSC -0.30%) maintains trucking partnerships, it does not offer the same integrated rail-to-highway option. This multimodal service combines the reach of truck transportation with the cost-advantage of rail.
Rail undeniably offers greater efficiency than trucking over long distances. Its fuel efficiency is four times greater than trucking, its greenhouse gas emissions are 75% less, and its capacity for bulk and carload goods is substantially greater. Rail transport also avoids the safety hazards and slowdowns of congested roads. Yet railroads' advantages may erode with advances in trucking transportation.
Trucking technology gains ground
Even though electric and driverless trucks are still years away from widespread adoption, the freight industry appears to be headed in that direction. Rapidly falling electric battery pack prices, expanding charging infrastructure, and improving battery energy density have increased driving range to the point that electric freight trucking starts to look viable. At the same time, autonomous trucking is expanding operations in the South and West, which offer fair weather and long stretches of uncongested highways.
These advances in the trucking industry will lower fuel and labor costs, narrowing the gap between rail and freight trucking. Intermodal customers such as J.B. Hunt (JBHT 0.43%), Hub Group (HUBG 0.39%) and UPS (UPS 0.78%) might shift much of their business toward trucking, entirely cutting out the rail leg in the transport process. Carload and bulk transport is profitable enough to sustain the railroads, but the loss of intermodal traffic to trucks would certainly lower growth prospects for railroad stocks.
The geographic advantage that CSX enjoys in the Eastern half of the US will help fend off competition as trucking efficiency improves. An integrated rail-to-highway offering, however, may ultimately position CSX to capture the traditional advantages of rail transport while still benefiting from advances within the trucking industry. In the meantime, CSX must find a way to integrate Quality Carriers in a way that improves operating efficiency.