Much of the reason the North American railroad industry continually leads other freight modes in profitability is its ability to match demand with capacity. This year looks to be no different.
This fundamental economic concept eludes the container shipping and air cargo industries, pushing carriers’ balance sheets deep into the red. And it’s only been in the last two years that the trucking industry has reined in capacity to the benefit of profit margins.
The railroad industry’s disciplined approach to capacity helps underscore its pricing power; railroads showed this again in the first quarter by boosting earnings on weak to moderate traffic growth. It certainly doesn’t hurt that it’s far cheaper to pull a railcar off the track than it is to park a truck, ground a jet or dry dock a vessel.
But the rail industry’s ability to match capacity with demand goes beyond having more asset flexibility. The strong parallels between current and forecast volume by commodity, and orders and deliveries for the respective equipment illustrate the industry’s deft balancing hand.
Although railcar orders between the first and fourth quarters of 2011 declined 25 percent, the falloff shouldn’t be seen as a sharp shrinkage in capacity growth but as a balancing of strong orders made in 2011. The backlog of railcar orders in the first three months was only 6.7 percent less than in the quarter before, and deliveries were nearly flat in the same period, according to the Railway Supply Institute. That suggests moderate demand for new capacity and the replacement of aging equipment for the year.
The rail equipment industry “is notoriously cyclical,” making it difficult to gauge when order surges are tied to forecast capacity growth, replenishment of aging equipment or other factors, said Larry Gross, a senior consultant for FTR Associates. What is more clear is that two of the biggest drivers for the rail equipment markets will be in the two areas that have experienced strong volume growth: domestic intermodal and domestic energy production, excluding coal.
About 2,760 53-foot well cars, used for domestic intermodal transport, were delivered in the first quarter of 2012. That compares to zero orders for 40-foot well cars, which are used for international intermodal containers, according to the RSI.
The only orders for intermodal equipment last quarter were for 220 non-articulated cars. There will be enough supply of domestic intermodal units, or 53-foot well cars, but shippers might find it harder to find the 53-foot containers toward the end of the year, Gross said.
Orders for international intermodal equipment will continue to be low, because volume growth is expected to be weak and there is plenty of capacity, said Richard Kloster, another FTR senior consultant. He expects strong annual deliveries and orders for tanker cars and small cubed hoppers, as domestic drilling for natural gas and oil expands.
However, even in that bustling sector, there has been a pause, as hydraulic fracturing, or fracking, for natural gas has slowed recently, Kloster said. Greenbrier CEO William Furman said demand for frack sand-carrying cars has waned because of a slowdown in natural gas exploration and production, according to Reuters.
“There has been a slowing down of the frantic pace,” he said. “An awful lot of cars have been ordered, an awful lot of production is in play. So I think there’s just a pause as people calibrate their demands.”
Greenbrier swung to a $17.7 million profit in its fiscal second quarter after losing $550,000 a year earlier, as the railcar supplier delivered 1,500 more railcars year-over-year. Orders doubled from the previous quarter to 3,600 units.
Just as manufacturing is boosting domestic intermodal, steadily expanding U.S. factory output is driving orders for tank cars, covered hopper railcars and auto racks. The latter also is driven by increased vehicle sales and the need for tri-level auto racks, as customer taste shifts from trucks and SUVs to compact cars. Trinity Industries, North America’s largest railcar manufacturer, said the majority of its orders for about 3,255 railcars in the first quarter were for those three types of equipment.
“For the year 2012, we are projecting delivery of approximately 19,000 to 20,000 new railcars,” Steve Menzies, senior vice president, told investors on April 26.
If the manufacturer hits its most conservative estimate, it will deliver 35 percent more railcars than in 2011 and four times as many than in 2010. Trinity doubled its profit to $52.9 million in the first quarter after shipping twice as many railcars compared to the same period last year.
With coal traffic down 11 percent year-over-year, it’s not surprising there were no orders for aluminum open-top hoppers and aluminum gondolas in the first quarter. Kloster said there is a surplus of coal railcar capacity and there isn’t a need for new orders this year. That’s unwelcome news for manufacturers, but just another sign that when it comes to the economic basics, the rail industry is on track.