Here’s a good bet: Intermodal, automobile and domestic energy-related traffic will grow on U.S. railroads through the end of this year and in 2013 as their engines of growth — volatile fuel prices and tightening truck capacity, the need to replace aging vehicles and booming natural gas production — aren’t likely to let up.
But wagering on how other types of rail volumes will fare is a gamble, considering the shaky domestic economic recovery and sluggish global growth.
Despite some signs the coal slump has bottomed out, it’s too soon to determine what’s ahead because volatile and unpredictable events such as natural gas prices, weather and tightening federal emissions go so far in determining shipment volume. The full impact of the U.S. summer drought, along with foreign demand, remains murky, for example. Even manufacturing, a key driver of the economic recovery, is showing signs of faltering, and that could pull down metals, metallic ores and chemicals shipments.
For all that, however, a major slowdown in U.S. economic activity is unlikely. Third quarter carload volume excluding coal and grain expanded 3.4 percent year-over-year. Total volume excluding coal rose 3.4 percent in September, the largest increase in four months and the 34th consecutive year-over-year rise, according to the Association of American Railroads. Intermodal traffic increased 5.5 percent year-over-year in the third quarter, and traffic was up 2.5 percent in September, the third-highest monthly average this year.
Intermodal shipments likely will grow in the mid-single digits in the fourth quarter, barring any major disruptions to consumer spending, John Larkin, a Stifel Nicolaus analyst, wrote in a note to customers. The investment research firm expects total U.S. volume growth in the fourth quarter to reflect the broader economic expansion of 1 to 1.5 percent.
That sluggish economic expansion likely will rein in railroads’ robust profit growth, evidenced by investors scaling back their profit forecasts for several major U.S.-based railroads ahead of their third quarter earnings releases. Norfolk Southern Railway was the only carrier to downgrade its own profit expectations, blaming weak coal traffic and merchandise shipments, and reduced fuel surcharges.
Still, the industry is expected to deliver solid profit, as Class I railroads’ well-run operations and pricing power have powered through weak volume growth in recent quarters. But higher fuel prices and the continued weakness of coal, one of the industry’s most profitable business sectors, might cap railroads’ profit growth. In fact, major U.S. railroads may already have hit that profit ceiling, as second quarter growth at the Class 1s other than privately owned BNSF Railway fell by half from the second quarter of 2011.
“The earnings season will be a bit tougher than in the first half,” said Tony Hatch, senior transportation analyst for ABH Consulting. “We’ve been seeing the same trends: good intermodal, lousy bulk and pretty good merchandise (shipments).”
That isn’t to say the railroads don’t have plenty of profit drivers. Domestic intermodal growth won’t slow, and international growth isn’t like it was in 2005 and 2006, but it’s still expanding, Hatch said. He expects international intermodal volume to grow 3 to 5 percent next year, and domestic intermodal to grow 5 to 10 percent. Increasing federal regulation and a lack of qualified drivers could “make truck capacity move from an issue to a problem very quickly,” he said.
The severity of tightening truck capacity and the resulting higher rates will determine whether intermodal growth is on the low or high end. The health of the intermodal market also will impact broader rail pricing for next year, Hatch said. Average pricing will rise about 5 percent if intermodal business performs well and about 3.5 percent if its growth is lackluster, he said.
Hatch expects the shipment of motor vehicles and equipment to see mid-single-digit growth in 2013. Although U.S. car sales jumped 12.8 percent year-over-year in September, the fastest rate of growth since March 2008, the sector “cannot exceed sales forever,” Larkin wrote. He expects double-digit growth in fourth quarter shipments before expansion slows to the mid-single digits in 2013.
The domestic energy production boom looks more sustainable. The railroads’ investments in supporting infrastructure are expected to pay off with more volume in 2013. Petroleum traffic jumped more than 40 percent in the third quarter year-over-year, according to the AAR. The shipment of metallic ores and metals, a key indicator of economic activity, is less certain as key manufacturing indices show production dipping and rising in recent months.
Coal volume, which declined 7.9 percent year-over-year in the third quarter, likely will stabilize in 2013 but still be down year-over-year, Hatch said. The fate of the commodity rests largely on the price of natural gas, the severity of the winter and the appetites of Asia and particularly Europe.
The health of export coal shipments, a small but highly profitable business for U.S. railroads, also depends on how fierce competition is from suppliers, namely Australia. Republican presidential nominee Mitt Romney also could pull back federal emission rules if elected, giving utilities an incentive to burn more coal.
Like coal, a myriad of factors will play into how long it takes grain shipments to rebound. In addition to the drought, a strong U.S. dollar and competition from Brazil, Australia, Russia, Ukraine and other suppliers have weakened export shipments, said John Gray, the AAR’s senior vice president of policy and economics. U.S. farmers also might be holding onto their harvests until prices improve, he added.
There are signs that grain traffic, which fell 0.4 percent in the third quarter, has bottomed out. Volume increased slightly in August and September year-over-year, although 2011 was hardly a banner year for crops, either. Hatch expects “significantly better year-over-year comparisons” in 2013 because the “U.S. will continue to be the breadbasket to the world.”
Perhaps, the top barometer for railroad volume and the broader U.S. economy in 2013 will be lumber loadings. “There is a very close correlation with lumber shipments and housing starts,” Gray said. Lumber and woods products shipments jumped 12.4 percent year-over-year in the first 39 weeks of the year. Housing sales, which tend to boost purchases of furniture and home furnishings, increased 4.6 percent in August from the same period last year, according to CoreLogic, a market research company.