Rail transport is an excellent business. The major companies involved all have steadily rising sales and profits, they all have strong profit margins, and they return capital to shareholders while retaining enough to reinvest in their businesses.
But at any given time there are usually one or two railroads that are out of favor. While the major railroad companies all have similar businesses, they have different geographies, and they therefore transport different goods. As some of these goods come into or fall out of favor, the related railroad companies’ share prices react accordingly.
Coal has been a particular weak spot for the railroad industry over the past few years, and those railroads that operate on the East Cost of the United States – Norfolk Southern and CSX have seen this weakness in their businesses.
Norfolk Southern felt coal-related weakness in 2011 and 2012, though the company has since recovered as a result of greater efficiencies and increased exposure to other sectors of the economy. During that same timeframe, CSX felt this weakness, but not nearly to the extent that Norfolk Southern did. As a result, CSX shares handily outperformed.
But over the past several months, the two East Coast railroads’ situations appear to have switched. During this most recent earnings season, Norfolk Southern reported strong year-over-year results, no doubt a result of 2012 weakness.
As a result, the shares rose to a new all-time high of $95.10 per share. On the other hand, CSX reported a relatively weak earnings number, and the shares fell from a high of $29.25 on January 14 to a low of $25.88 on January 27. This is a sizeable fall in the share price of a relatively stable company that has shown profitability and stability even in a weak economy.
CSX’s weak earnings number was the result of lower profits resulting from a decline in profit margins — a result of a reduction in coal shipments. But we have seen this story play out very recently with CSX competitor Norfolk Southern. While weakness persisted in that company’s earnings and share price for a couple of years, this weakness turned out to be a great buying opportunity.
I suspect that something similar with happen with shares of CSX. They will not immediately jump to all-time highs and weakness will persist, especially given the Environmental Protection Agency’s stringent regulation of the coal market. However, coal is just one part of CSX’s business, and the company’s oil, agriculture, and intermodal businesses will all continue to be strong; over time, they will overshadow weakness in coal.
More generally, the railroad industry remains a place that investors should be putting their money. These companies are stable profit generators. They operate as a de facto oligopoly, as there are extremely high barriers to entry. Furthermore, with rising fuel costs, rail transport is a better option than truck or air freight for those looking to ship large amounts of goods.
This economic advantage is compounded when we realize that railroads have far smaller labor costs than trucking and air freight companies. A train is akin to hundreds of trucks linked together. But while 100 trucks need 100 drivers, a train needs just one engineer.
With the railroad industry as strong as it is and with temporary weakness in CSX’s business and share price, I think the shares offer a unique opportunity for long-term investors.