Railroads maintain pricing power despite lower volumes

One analyst says trend defies law of supply and demand

By Dave Hannon -- Purchasing, 4/24/2008 11:31:00 AM

U.S. railroads continue to report increased pricing power despite an ever-slowing U.S. market and declining overall freight volumes.

This week, Kansas City Southern reported a 9.6% increase in quarterly revenue attributable to “a continued strong pricing environment and carload/unit growth in some of the company's business segments.” The railroad’s carloadings declined 1% overall in the quarter, according to company data, but revenues from carloads jumped 9%.

Rail and intermodal provider CSX surprised analysts by reporting record first quarter revenues which it gained “through yield management, fuel recovery and market drivers including growth in ethanol and grain shipments, increased demand for export coal, and a stable industrial economy” according to the company’s statement. CSX said ethanol volumes doubled year-over-year in the first quarter but its overall rail volumes declined by 3% while its intermodal volumes were relatively flat.

Last week, CSX CEO Michael Ward said average rail rates would increase 5-6% this year. Norfolk Southern’s CEO Wick Moorman told Reuters this week he expects the railroad to raise freight rates by a "minimum" average of 4% this year across all commodity groups.

Despite a 47% increase in average fuel price, Union Pacific reported better-than-expected revenue in the first quarter and credited price increases and higher fuel surcharges for its 11% increase in quarterly revenue. 

So what gives? How can an industry that is seeing declining demand and is coming under increasing pressure regarding its pricing practices continue to command such increased pricing?

In a recent Reuters report, Andrew Meister, a portfolio manager at Thrivent Investment Management, theorized that "On the face of it, it doesn't make sense that freight volumes are going down but prices are going up as that contradicts the theory of supply and demand. But I'm beginning to think the railroads experience 20-year cycles and that regardless of the economy right now, customers will end up paying more even if they move less freight."

Another industry source, speaking to Purchasing.com anonymously, suggested that as a railroad gets a higher percentage of its customer base onto contracts with fuel surcharge programs, its revenues will improve regardless of volumes.

"And while overall volumes have declined slightly, railroads are gaining more market share [vs. trucking] in this environment, improving their pricing power in the logistics market," the source says.

Citigroup analyst John Kartsonas suggests in a recent note that “Strong pricing, productivity improvements and share buybacks continue to provide the great majority of the EPS improvement in a sector where the core business of transporting goods continues to contract.”