The “railroad renaissance” has been tested in 2007 as never before; after the breakthrough years of 2003-06, the rapid volume growth and paradigm shifting pricing power has been challenged by declining volumes that led to questions on the durability of rails’ newfound pricing power. In addition, Congress, in its infinite wisdom, has taken up rail issues as a front-burner item, leading to fears of added cost burdens and perhaps even re-regulation.
So why should investors (and others) keep the faith?
1. Money, which can be defined here as for the shipper in terms of cost (for example, as opposed to the highway) advantage, or for government in tax (the tax-paying railway versus the tax-absorbing highway), or as a result, in returns to shareholders. Anyway you look at it, it’s the money that drives economic decisions and will be the long-term basis of the story of the railroad renaissance. Money is the central theme.
2. Trade. It’s clear that with globalization, longer supply chains, worldwide sourcing and risk spreading, trade will continue to grow in importance (as measured as a percentage of national or global GDP, for example. Wthin the logistics chain, transport is also growing as a component after years of shrinking. This obviously plays to rails’ strengths
3. Congestion. It’s getting worse (estimated at $67 billion-a-year drag on the economy as of 2005, it’s already bad) and the solutions are expensive. The railway is a low-cost alternative for governments, and for truckers, who are clearly seeing productivity declines due to roadway congestion (among other things).
4. Returns. Or the virtuous circle — in which the better revenues and better rates the industry has recently been enjoying is translating into higher growth in capital expenditures, which is allowing more growth, at higher rates … if this circle remains unbroken, it can be a beautiful thing for all stakeholders.
5. Capital. They sure spend a lot of it in this industry, up to (and recently exceeding) 20 cents on every dollar of revenue — by far the most capital-intensive industry — so the returns are absolutely critical to maintain the capital. But there are increasing sources of capital, from traditional to new investors, lenders, suppliers and others willing to participate. If No. 4 continues so will No. 5.
6. Stable regulatory environment. All of the above assumes that the noise in our nation’s capital remains just that, noise. Any major changes (and too large an accumulation of “minor” ones) in regulations will threaten returns and chase away capital.
7. Grain. Why pick one commodity? Well, intermodal is clearly the story of the renaissance, so far and to come, but grain’s emergence from wildly volatile to reliable has been a major sub-theme. This has not always been easy, but an increasing amount of the business is unit train, often in shuttles, and domestic (feed) as well as global. And there’s ethanol, of course, right?
8. Technology. This includes not just the current major investment but what’s on the horizon: better Internet-based communication among carriers, and between carriers and shippers; and better software-based operations systems driving all rail operating plans. There is also a potential home run in the intermediate future being tested: ETMS (enhanced traffic management system) and ECB (global positioning and better breaking) technologies that could increase safety and add 10 to 20 percent to capacity in a constrained environment.
9. Society. The “soft” societal benefits are becoming more important — congestion relief, lower emissions, increased road safety, lower dependence on foreign oil and the productivity benefits of having an efficient national transportation network.
10. There’s more to come. Technology is just part of the story. There are also the productivity benefits of running a more reliable system — and of finally solving the carload problem. Manifest trains may be shrinking as a percentage of the total as intermodal and other traffic grows, but it’s still a huge business. As rail reliability, cooperation (and information sharing) and technological capability improves, “solving the carload problem” is actually within sight.