First-quarter railroad earnings analysis: Growth in shale, chemicals, autos, steel and intermodal traffic offset coal decline — by Tony Hatch

— by Tony Hatch

In the beginning of 2012, rails faced what appeared to be the crisis of a lifetime, a nightmare scenario of a still-uncertain economy and what some have dubbed "the end of the coal age." Yes — the end for coal, King Coal, the bedrock commodity that sustained rails through the dark, pre-Staggers days.

So, how did rails perform in the first quarter? Well, their earnings per share collectively increased fully 33 percent, perhaps five times more than the overall market and a third more than the befuddled Wall Street consensus numbers.

How did they do it? Railroads had compensating growth in other areas — much of it shale related (the hand that taketh also giveth), as well as chemicals (itself an industry given new life by cheap natural gas), autos, steel and intermodal. And they proved they can continue to increase productivity (in this case, the warm weather that giveth the utilities stockpiles also taketh cost out of railroading — as well as systemic improvements). The rails also began what will be an all-time record capex year ($13 billion!) while increasing both dividends and share buybacks. Some crisis!

And now, a summary of the factors that helped shape Q1 financial results:

• Coal was down 10 percent, as was grain, for unrelated and rather temporary reasons. Coal faced a triple whammy: the warmest winter in a century (electric output down some 6 percent-plus), upcoming environmental regulation and legislation, and cheap and abundant natural gas. But coal has been declining since 2008 and the rails have proved remarkably resilient to macro change (see the decline of U.S. manufacturing versus globalization/double stacking, or the decline of auto manufacturing versus "assembly"). We will at some point, likely later this year, reach the new normal for coal, which will remain some 35 percent to 40 percent of utility fuel sourcing.
• Taking out bulk commodities, traffic collectively was up 6 percent — a real vote for a stronger economy than the headlines would have us believe, as well as share opportunities.
• Rail pricing remained solid, up some 4 percent to 5 percent. Rails — and utilities — do not expect any pricing decline due to the coal story.
• Operating metrics, helped by the huge capex spend — and of course the mild weather — improved dramatically.
• The operating ratios collectively improved some 266 basis points to just over 72 percent, excluding Canadian Pacific's 1,050 basis-point improvement.
• Shale — frac sand, aggregates and pipe, water and brine, "rolling pipelines" — and related positive developments (domestic chemical and steel production) don't yet compensate for the coal decline, but the gap is narrowing. Cyclical recovery and the intermodal story push rails over the hump.

The first quarter sets the stage for the rest of the year: coal concerns, yet solid earnings growth as the recovery continues and share is regained. For rails, the future looks greener — and brighter — than ever.

Tony Hatch is an independent transportation analyst and consultant, and a program consultant for Progressive Railroading's RailTrends® conference. Email him at abh18@mindspring.com.