Business Is Too GoodIndeed, the planets are aligning for railroads. Demand is so strong that many companies are seeing results falter because they cannot keep up. From coast to coast, retailers and manufacturers are turning to intermodal shipping, where truck trailers are hauled over long distances by trains, then unloaded onto trucks for local delivery.
|Tracking the Railroads |
|Company||Price-to-2005 Earnings||Analyst Ratings||YTD % Change*|
|Kansas City Southern||18.51||2||1||2||-2.9|
|*Through April 28, 2004 Source: Bloomberg, Baseline, TSC Research|
Don't Fight the FedBut railroads face other risks, which could eat into profit growth even if they're able to overcome the execution risk -- notably rising interest rates and inflationary pressures. Since 1988, according to research from Citigroup Smith Barney, the railroad sector has always underperformed the broader market in the year after the Federal Reserve hiked interest rates. The most recent gross domestic product data show not only 4.2% growth, which is good for railroad earnings, but also a rising risk of inflation, which is not. "Overall, in the last 15 years, the rail stocks have typically underperformed the S&P 500 by 14.1% in the year following an initial rate increase," said Scott Flower, Citigroup's railroad analyst. "This is not unexpected given the highly asset-intensive nature of the railroads and their early cycle characteristics." Indeed, as cyclical stocks, railroads are an early tell on a wide variety of economic signals, from recovery to Fed tightening. Rising rates would hurt the industry, boosting interest costs, but a fall in the price of oil would help results, making it hard to rely solely on one item to determine performance going forward. As Flower notes, over the last 10 years, railroads have outperformed the S&P 500 by 17% in the year after oil prices peak. And this time around, analysts say that rising rates might not have such a major impact -- after all, interest rates are already near record lows. "While we do not intent to fight history on this issue, we would suggest that the direct earnings impact to the rails this time is minimal, and we believe that we can see sustained double-digit EPS growth in 2005, even with milder 3% GSP assumption," said Valentine.