Railroads Back on Track?

After years of retrenchment, railroads across North America are reporting record profits and rolling forward with massive expansion projects of the kind that haven’t been seen in decades.

The growth has been fueled by a flood of cargo containers filled with Asian products, which ended the coal industry’s 102-year streak as rail’s biggest revenue generator in 2003 and has surged further ahead since then.

Railroads are gaining ground on the rival trucking industry, which has been suffering from sharply higher diesel costs and a shortage of long-haul drivers. But companies that move their goods by train are complaining about increasing rates and delays.

“It’s a new day a-dawning for the railroads,” said Don Hodges, whose Hodges mutual fund lists railroads as some of its largest investments. “The railroads have been underperformers for so many years that people stopped paying attention to them. I think there is a lot ahead of them even yet.”

The change is most evident along the route from the ports of Los Angeles and Long Beach to Chicago, the nation’s busiest freight corridor for intermodal shipping traffic -- the large steel cargo containers and truck trailers that can move by ship, rail or truck.

Southern California’s biggest movers of intermodal traffic, Union Pacific Railroad and BNSF Railway Co., posted strong earnings for 2005. That performance contrasted with the railroads’ struggle in 2004 to keep pace with crushing congestion that began at the ports and crept inland to the tracks. They had to turn away cargo or leave it sitting for as long as two weeks before moving it east.

Omaha-based Union Pacific Corp., the nation’s largest railroad, reported 70% growth in 2005 net income to $1.03 billion while revenue jumped 11% to $13.6 billion. Fort Worth-based Burlington Northern Santa Fe Corp., which owns the second- largest railroad, earned a record $1.5 billion, up 93%, on revenue of $13 billion, up 19%, for 2005.

No. 3 CSX Corp. reported that 2005 net income rose 237% to $1.2 billion and 2005 revenue increased 7% to $8.6 billion. No. 4 Norfolk Southern Corp. saw its net income rise 39% to a record $1.3 billion in 2005, while revenue rose 17% to $8.5 billion.

“I am particularly pleased that we converted strong revenue growth into a significant increase in operating income,” Union Pacific Chief Executive James Young said about his company’s 2005 performance during a conference call with investors and analysts. BNSF Chief Executive Matthew K. Rose, in a similar call, described “a systemic change in the demand for rail transportation ... and this new environment creates tremendous opportunities for us to grow business.”

Despite its turnaround, Union Pacific received relatively little praise on Wall Street.

A.G. Edwards & Sons analyst Don Broughton, for instance, took Union Pacific to task for its “anemic” 5% growth in intermodal cargo volume, which would have seemed strong in almost any other year. BNSF managed nearly 10% intermodal growth. Industrywide, intermodal rail freight rose nearly 7% to 11.7 million containers and trailers in 2005; total volume, which includes freight moved in rail cars, rose 2.4% to $1.69 trillion ton-miles.

“The industry for many years was cursed with overcapacity. Now, we aren’t. It’s a sea change for us. We have gone from having to chase freight business to having freight customers chase us,” said Tom White, spokesman for the Assn. of American Railroads.

Railroads move more than 40% of the nation’s freight tonnage compared with nearly 30% moved by truck, but railroads reap about 10% of freight revenue while trucking companies take in about 80%, according to the rail trade group. Railroads are gaining more of that revenue because the goods moved in cargo containers tend to be more expensive than the coal, grain and other commodities that ride in rail cars.

In addition, the greater fuel efficiency of trains in an era of volatile prices and a dearth of truck drivers is having an effect on long hauls, transportation analysts said. The American Trucking Assn. said the nation was 20,000 short of the drivers it needs, a figure it expected to rise to 80,000 by 2010.

Business has been so brisk that railroads are having trouble maintaining their targeted average speeds and delivering goods on time. Meanwhile, they’ve been able to pass along fuel-price increases and raise rates for the first time in years, by an average of 15% from November 2004 to November 2005 for intermodal cargo, according to Logistics Management, a trade magazine for supply chain professionals.

Neither trend sits well with customers.

YRC Worldwide Inc., the Overland Park, Kan., company that until recently was known as Yellow Roadway, moves intermodal freight with its trucks and by rail. YRC Chief Executive William D. Zollars last month blamed railroad rate increases, new charges for trailers that formerly were free and service problems for reducing company earnings.

“On-time rail performance continued at well below acceptable levels, which has caused additional inefficiencies in our networks,” Zollars told analysts.

Atlanta-based package shipping giant United Parcel Service Inc. has paid $1.5 billion to “every railroad of consequence in North America” since the start of 2004 to send items moving by ground to their destinations. Deteriorating on-time performance has become intolerable, spokesman Norman Black said.

“If packages arrive an hour late by rail, that is a big deal to us. We have to hold people and pay them overtime for that hour,” said Black, who added that the quality of rail service “is not what it should be in this country.”

Jim Hathaway, general manager of Dunn Energy Cooperative in Menomonie, Wis., said the co-op would need to charge its 9,000 electricity customers as much as 15% more because BNSF had raised rates on the utility’s coal shipments.

“It makes me sick,” Hathaway said. “It’s very disappointing to have a railroad charge exorbitant fees for services we can’t get anywhere else.”

Hathaway is urging the co-op’s customers to support a bill introduced by Rep. Mark Green (R-Wis.) in 2005 that would strip the railroads of antitrust protections.

“More and more, our farmers, our electric utilities and our manufacturers are served by only one rail company that sets its rates seemingly at whim. People across Wisconsin are struggling to keep up with the rising costs of rail,” said Green, who hopes to get a Judiciary Committee hearing on his bill in the coming weeks.

To accommodate the freight deluge and cool customer anger, railroads began investing heavily in building track and buying equipment in 2004.

BNSF says it will increase capital spending by about 10% to $2.4 billion on new track, 9,000 new double stack cars and 310 locomotives in 2006. Union Pacific will spend about $2.7 billion, down slightly from $2.9 billion in 2005, on 145,000 tons of new rail, 200 more locomotives, 2,700 new or leased rail cars and to hire 3,600 trainmen and engineers.

But rail experts and customers fret that even that pace of investment among the big railroads won’t be enough.

BNSF provides a clear example. Railroad analysts point to BNSF as a good model of how to run a railroad, but even it is running into trouble.

BNSF saw its freight car velocity drop from more than 205 miles a day in 2004 to 183 miles in 2005. BNSF’s on-time performance has fallen from 92% of its trains in 2002 to 71% in 2005, systemwide.

“Railroads are like juggling,” said Randy Cousins, a railroad analyst for BMO Nesbitt Burns. “If I keep tossing more balls at you, it’s not going to work. The railroads have had so much volume coming at them and the track miles really haven’t changed that much.”

The railroads say they are doing what they can to keep pace.

“We have our own projections and they are significant,” said Robert Reilly, general manager for BNSF’s Los Angeles division. “We are trying to handle the volume increases that we have managed to handle every year. We are prepared to handle that for 2006.”

Tom Jacoby, Union Pacific’s vice president for the West region, explains his optimism about the railroad’s abilities to build what is needed. He was stationed in Nebraska in 1988 when the railroad was operating six coal trains a day with about 115 cars each through the Powder River Basin coal country of Montana and Wyoming. Now, Jacoby said, Union Pacific runs 80 trains a day with 125 to 130 cars along the same route.

“As the need grew, we continued to invest in capacity,” he said.

“We will see continual growth in the L.A. area in international cargo, and we will continue to invest in meeting it.”