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Is the Railroad Industry Gearing Up for Consolidation?

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Consolidations in the 1990s

The Staggers Rail Act of 1980 paved the way for railroads to compete in the market. Since then, the US railroad industry has seen a series of consolidations and combinations. These combinations have reduced the number of major US rail carriers to seven from 56. However, a series of accidents, cargo and monetary loss, and derailments after these mergers has led some to question the logic behind consolidation. The STB (Surface Transportation Board) laid down specific rules in 2001 that made consolidations extremely tough.

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Changing diaspora

The US rail industry hasn’t seen any major consolidations since 2000. Following the subprime era, the revenue growth for all major railroads has been a matter of concern. Margin pressures and operating efficiency concerns are making a strong case for consolidations.

The railroad industry is affected by demands of commodities such as crude, grains, chemicals, and coal. Energy-related commodity prices are under pressure. Weak commodity prices are hampering the pricing ability of major railroads and shrinking their bargaining power.

A pro-consolidation Hunter Harrison

During Canadian Pacific’s (CP) fourth-quarter earnings call on January 29, 2014, CEO Hunter Harrison said, “I do think there will be consolidations in the future,” adding, “for example, you split up East and West, you got two in the East, you got two in the West. And a merger across the Mississippi River is not going to impact the competitive environment.” So is the industry gearing up for consolidation?

Although nothing can be said with certainty, we can get some idea of where it’s headed based on what industry veterans are saying in light of CP’s aggressive bid for Norfolk Southern (NSC). NSC’s peer group consists of CSX Corporation (CSX), Canadian National Railway (CNI), CP, Kansas City Southern (KSU), and Union Pacific (UNP). The SPDR S&P 500 ETF (SPY) holds 0.38% in UNP, 0.14% in NSC and CSX, and 0.04% in KSU. Altogether, this ETF holds 0.70% in Class I railroads.

 

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