Railways positioned for long-term growth despite deep volume drop
Source: Canadian Press
Published: January 15th 2009

MONTREAL Canada's railroads won't be derailed despite being tested by the worst downturn since the industry was deregulated nearly 20 years ago, industry observers say.

"We're seeing traffic drop off fairly sharply right across the board," says Cliff Mackay, president and CEO of the Railway Association of Canada.

A dramatic drop in volume in late November has sustained itself through the new year. The size of the decrease should be known next week when CN Rail (TSX:CNR) and Canadian Pacific (TSX:CP) disclose their quarterly results, but Mackay said it exceeds 10 per cent.

The impact has been felt across most product categories, not just the struggling forestry and automotive sectors.

It is the result of a general economic slowdown spurred by weak consumer demand and confidence, along with dramatically reduced commodity prices and traffic from China.

Mackay said railways will become more cautious in the short term to preserve cash by controlling costs and maintaining customer service.

CN and CP declined to comment because they are in a black-out period ahead of the release of their results.

The association called on Ottawa to earmark infrastructure spending in the budget.

"We think that the federal government could easily allocate a couple hundred million dollars, if not more, to the freight-oriented part of the rail transportation system and get a very good bang for their buck."

Projects include building more rail overpasses and underpasses.

The association has also approached the provinces to help short-line railways whose ability to generate cash is restricted by lower revenues.

Ontario is being asked to provide $95 million. Quebec is in the process of spending $75 million earmarked some 18 months ago.

Despite the short-term challenges, the railway sector is expected to pick up late next year or early in 2010. RBC Capital Markets analyst Walter Spracklin said North America's railroad industry is positioned for long-term growth.

"Despite the current period of economic weakness, we believe that the long-term demand for goods will grow over time and that this will lead to steady and sustainable growth in demand for railroad transportation services," he said in a report.

Railways will continue to gain market share from alternative forms of transportation, Spracklin added. Its share of cross-border traffic has grown over the past six years by about 10 percentage points to 55 per cent.

Trucking-related challenges such as highway congestion and higher operating costs for fuel will continue to help railways that have improved their service and lowered costs, Spracklin wrote.

And once customers transfer to rail, they are less likely to switch back to higher-cost trucking in an environment of economic uncertainty.

Railway freight demand is expected to increase 88 per cent by 2035 from 2002 as total demand for freight transportation nearly doubles to 37.2 billion tons, according to the U.S. Department of Transportation.

Significant pricing power, strengthened by tight capacity, gives railways the edge as multi-year contracts help to mitigate volume softness.

A recent study said rates exceeded seven per cent annually between 2003 and 2006, after being relatively flat between 1987 and 2003. Spracklin expects prices will grow at a slower pace of three to four per cent in 2009.

Although some shippers have begun to protest freight rates, government agencies are unlikely to intervene with regulations because it could impede future company-funded infrastructure upgrades, Spracklin said.