Railroad Costs and Their Value

Posted 28 Dec 2008

JL asked a very economically intuitive question, "Are their any index’s for us Rail/Trucking such as BDI for bulk shipping?"  Because of my experience with those industries I immediately thought the answer would be no but decided to do further research and came across some interesting findings.

There appears to be no general pricing index rail services in the United States.  To get a better grasp on how pricing is determined in the industries I talked to the Chairman of the Board of a leading railroad engineering company.  He joked that the railroads "Charge until they squeal."

 He said he was unaware of any general index, that most prices are set between private parties according to the needs of the contracts and unlike bulk shipping by boat there are large variances in the rail industry with the types of cars, distances and products to be shipped.

He suggested I investigate the Association of American Railroads for more information whose members account for more than 96% of intercity rail freight service and essentially 100% of passenger service and includes such large railroads as CSX (CSX), Burlington Northern Santa Fe (BNI), Norfolk Southern (NSC), Union Pacific (UNP),  Canadian Pacific (CP), Canadian National Railway Company (CNI) and Kansas City Southern (KSU).

The railroads have played a significant role in the development of American jurisprudence.  Railroads are the backbone transportation infrastructure.  If anything is moved on a regular basis in America then it is probably done by railroad.  

As railroads matured during the 19th century they had a large effect in shaping entire branches of the law such as eminment domain, tort and interstate commerce.  With an industry so entwined with the law it is not surprising that 49 U.S.C 10708 provides the Rail Cost Adjustment Factor (RCAF).

Under the code "(a) The Board shall, as often as practicable, but in no event less often than quarterly, publish a rail cost adjustment factor which shall be a fraction, the numerator of which is the latest published Index of Railroad Costs (which index shall be compiled or verified by the Board, with appropriate adjustments to reflect the change in composition of railroad costs, including the quality and mix of material and labor) and the denominator of which is the same index for the fourth quarter of every fifth year, beginning with the fourth quarter of 1992.

(b) The rail cost adjustment factor published by the Board under subsection (a) of this section shall take into account changes in railroad productivity. The Board shall also publish a similar index that does not take into account changes in railroad productivity."

Interestingly back in July I was asked by a reader whether to sell their railroads.  As I give only general and not specific advice I assumed the portfolio is equally weighted between BNI, CSX and UNP, all purchases were made February 4, 2004 and one year performance began July 2, 2007 to present.

 Dividends are only closely estimated so the returns are probably overstated but fairly immaterial.  For this article, I decided to revisit the earlier conclusion to sell.

 As of August 15, 2008  the one year returns were 22.59% in FRN$ and (25.06)% in goldgrams (gg).  Returns as of December 28, 2008 were (21.85)% in FRN$ and (44.25)% in goldgrams.  It appears they made the correct decision selling the railroads.

The American Association of Railroads also releases a weekly volume freight report.  The same stasis that appears to be affecting the Baltic Dry Index and Long Beach Port appears to be infecting the railroads with carload freight down 16.7 percent from last year.  

"Cumulative volume for the first 51 weeks of 2008 totaled 16,372,331 carloads, down 1.9 percent from 2007; 11,393,179 trailers or containers, down 4.0 percent; and total volume of an estimated 1.71 trillion ton-miles, down 0.9 percent from last year.

On Canadian railroads, during the week ended December 20 carload traffic totaled 59,159 cars, down 24.8 percent from last year, while intermodal volume totaled 41,086 trailers or containers, down 11.2 percent from 2007." 

 It appears that empty ships lead to empty railroads and empty trucks.  The Canadian economy appears to be slowing even faster than the American counterparts.

The deflationary credit contraction is unmovable and unstoppable.  No amount of bailouts, currency printing whether physical or electronic, TAFs, TALFs or CRAPs are going to make any difference.  As the Financial Insanity Virus spreads the worldwide economy is slowing into stasis at a faster rate.

There have been significant declines in the prices of CSX (CSX), Burlington Northern Santa Fe (BNI), Norfolk Southern (NSC), Union Pacific (UNP),  Canadian Pacific (CP), Canadian National Railway Company (CNI) and Kansas City Southern (KSU).  This raises the question of whether any of these railroads are currently a good value?

Because of the heavily regulated nature of the railroads, the deflationary credit contraction which has barely started and the decline in discounted future cash flows in terms of gold to expect from the railroads I do not think the railroads are currently a good value.

 They do have significant and valuable capital investment that will be extremely useful and profitable in the future especially in context of Peak Oil.  Railroads have been the backbone of the United States economy for over 150 years and so long as there is any functioning economy they will continue to be in the future.  When will the railroads be a good value?

During a deflationary credit contraction the last layer to evaporate will be the currency through hyperinflation.  This is a currency event and requires neither a functioning economy nor an increase in the velocity of the currency.

 Gold is a currency and like all commodities is produced because it adds value to society.  The primary value gold adds to society is in performing mental calculations of value.

Based on current performance and balance sheets and assuming no significantly material changes I would consider purchasing the railroads at the follow prices:  CSX (CSX) at .276gg, Burlington Northern Santa Fe (BNI) at 1.042gg, Norfolk Southern (NSC) at .544gg, Union Pacific (UNP) at .617gg,  Canadian Pacific (CP) at .252gg, Canadian National Railway Company (CNI) at .235gg and Kansas City Southern (KSU) at .152gg.

Where those prices will be in FRN$ is anybody's guess as the FRN$ is an unreliable tool for performing mental calculations of value because it has no definition.  Until good values come around simply avoid the derivative illusion and burrow to the safest and most liquid assets which will only increase in purchasing power.

 But be sure you own the real thing and not some encumbered flimsy impostor like GLD or SLV.

Disclosures:  Long physical gold and no other positions.