The U.S. economy is galloping along, but President Trump’s infrastructure surge never materialized. That is great news for companies occupying key transport bottlenecks.
Railroads might seem like a very 19th-century investment, but as U.S. manufacturing shows glimmers of its olden-day prowess, buyers might find themselves rewarded. U.S. factories, running at their hottest since 2005, are churning out goods that need to reach market. Rising competition for scarce shipping capacity and already-pricey trucking mean railways still have plenty of scope to push rates higher and to defend margins as their own costs rise. Norfolk Southern Corp. NSC -0.21% , with a network concentrated on the densely populated Eastern U.S., looks well-placed.
For the first time since at least the early 2000s, trucking costs are rising faster than rail costs, even though rail is often cheaper. As a result, manufacturers are beginning to substitute rail for long-haul trucking on larger portions of their routes, sacrificing speed for cost. Norfolk’s revenue from so-called intermodal shipments—container traffic coming from or going to trucks and ships—was 20% higher last quarter than a year earlier, while per-unit pricing was up 8%. That far outpaced its overall operating revenue and pricing gains of 10% and 4%, respectively.
The trend is likely to accelerate in the third quarter. Long-distance trucking costs rose 12% on the year in July according to Labor Department statistics—the fastest since at least 2004. Rail costs rose by just 6.2%. As U.S. transport capacity keeps getting tighter, railroads still have plenty of scope to raise prices without losing customers. Norfolk, according to the company, has the most extensive intermodal network in the Eastern U.S.—leaving it uniquely well positioned to benefit from this trend. Railroads have their own congestion problems, but many of the recent issues have been at competitors such as CSX, which is in the midst of implementing a new “precision railroading” scheduling strategy, and at Union Pacific, which has been dealing with a major tunnel collapse in Oregon.
The cost side of the equation is equally important. Trucking companies are raising prices fast, but they are also getting killed on costs—the labor market for truckers is ultratight and fuel costs are high. As a result, even though trucking companies like JB Hunt are seeing sales grow briskly, their margins aren’t great. JB’s second-quarter operating margin was 10%, according to FactSet, down from 12% in late 2015. Norfolk’s was 35%, near its highest this millennium, and up from 27% in 2015.
One concern is valuation. Norfolk Southern trades at 18 times forward earnings, a touch higher than the S&P 500 at 17 times. But the capital-intensive nature of railways—and their position atop a crucial logistics bottleneck—means they can do well when the economy is running hot, rising variable costs are hitting competitors and spare capacity is limited. Investors should consider hopping aboard.
Write to Nathaniel Taplin at [email protected]