Seeking Alpha: Railroad Companies Have Been Losing Alpha Returns Over The Years
Posted on April 6, 2015
- Railroad companies, having once generated alpha, have failed to do so since 2012.
- High-speed rail plans and increased airline ticket sales are contributing to competitive pressures for the industry.
- In particular, high-speed rail could potentially disrupt traditional railroad traffic between large American cities, threatening a valuable resource to such companies.
The environment for American railroad companies has no doubt changed over the years. When taking into account the historical returns of four railroad companies, we see that while three of the four generated alpha returns from 2008-2012 as calculated by the Capital Asset Pricing Model, the four railroad companies in question have failed to generate alpha from 2012 to the present date – alpha being a rate of return above and beyond the expected return for bearing the risk associated with the stock. For reference, the four companies included in the analysis are CSX Corporation (NYSE:CSX), Kansas City Southern (NYSE:KSU), Norfolk Southern Corporation (NYSE:NSC), and Union Pacific Corporation (NYSE:UNP).
Clearly, there has been a big shift in returns over the period. Additionally, it is noteworthy that 2012-2015 has represented a period of prolonged gains for the S&P 500, while 2008-2010 was largely a recessionary period. This suggests that the downturn in returns is industry specific.
Firstly, on a valuation basis, we see that the P/E ratios of these four companies are more or less trading in line with their 5-year historical average (with KSU arguably having a certain degree of upside).
With steady earnings growth and reasonable valuations, firms in the railroad industry have been making decent progress and achieving reasonable returns. However, it is worth exploring why such returns no longer fall in the alpha bracket, and changing industry trends appear to be a significant contributing factor.
For instance, The Economist argued in 2013 that with an upsurge in what were previously low airline ticket sales, domestic flights continue to remain highly popular with little need for rail transport between major city hubs. The article also makes an interesting comparison with Europe, in that many American cities outside of the major metropolis areas simply do not have sufficient passengers to justify train travel. Additionally, much of America’s rail network is used to transport freight rather than passengers, and this has been known to lead to passenger delays as trains prioritize freight services.
Additionally, I expect that high-speed rail will come to pose a significant threat to traditional rail transport. The biggest markets for these types of serviceswould be through major cities – one example being a 90-minute journey from Dallas to Houston. Such transport between major cities has in many cases proven successful in Europe. For instance, the high-speed Spanish AVE line from Barcelona to Madrid has become so popular that Iberia’s passenger numbers for this route have declined by 40%. While traditional railroad services might be able to compete for services between smaller cities, passenger numbers have often been too low in such localities. Therefore, traditional railroad companies risk losing valuable market share to high-speed rail on routes in more populated cities. Additionally, companies such as CSX are opposed to integrating high-speed rail as part of their services, as the costs of infrastructure would be too high.
In conclusion, while railroad companies have generated reasonable returns over the past few years, I see it unlikely that they will be able to reclaim alpha returns specifically. Additionally, with higher airline passenger numbers and plans for high-speed rail underway, the competitive position of these companies may fall under threat.