Railroads: Pricing Power Continues; Some Early Signs of Logjams

In a recovering economy, few companies enjoy the massive leverage of railroads. As freight loads increase and begin to consume nearly all rail capacity, the companies simply jack up prices and enjoy the fattened bottom line. That sent net income up 16%, for instance, during the first half of the year at Union Paccific (UNP). The key to that performance was indeed pricing, as average revenue per car rose 10% for the first half, versus a year ago, faster than volume increased, at about 4% overall.

CSX (CSX), too, is enjoying the increased business, and is straining to add workers, locomotives and rail cars to keep up with demand. As YCharts noted nearly a year ago, these two companies are the biggest plays in rail since Warren Buffett’s Berkshire Hathaway (BRK.A) bought Burlington Northern. Buffett likes businesses with protective moats around their franchises, and few have wider moats than railroads, with their irreplaceable tracks across the country.

Union Pacific and CSX have sprinted past the broader market since bottoming out in early 2009.

Union Pacific Corporation Price Stock Chart by YCharts

Union Pacific and CSX earnings have been growing fast enough that, even with the shares of each doubling, the PE ratios have remained reasonable.

Union Pacific Corporation PE Ratio Stock Chart by YCharts

Question is, do these stocks have more room to run? If the economy does, they do. The railroads have become more efficient in recent years, building huge intermodal rail terminals outside Chicago, for instance, that more rapidly allow loads to be transferred and shipped further east after coming from the West Coast. The hope is that in this expansion – unlike previous ones – the increased investment will prevent massive logjams that slowed rail traffic and hurt the business, even as the economy kept expanding.

So far, Union Pacific is doing well, its average train speed for the first half of 2011 slowing just 1% to 26.1 miles per hour. Average time spent at a terminal rose just 2% for the period, so the freight is still moving despite increased volumes. CSX had some problems, with second quarter on-time arrivals slipping to 56% from a far-better 71% a year earlier. That’s one reason CSX is looking to add as many as 250 more locomotives, more workers and cars – to speed up and not anger its shipping customers.

Union Pacific and CSX require huge capital investments so they’re not the best dividend payers around, but they’re not miserly, either.

Union Pacific Corporation Dividend Yield Stock Chart by YCharts

The slowdown in jobs growth doesn’t help, and the current needless drama over raising the federal debt ceiling isn’t helping, either. If the recovery slows significantly, rail pricing leverage will be weaker. But these companies are uniquely positioned to benefit from economic growth. If you are bullish on the U.S., they’re worth a look.

Jeff Bailey is an editor for the YCharts Pro Investor Service which includes professional stock charts, stock ratings and portfolio strategies.