Analysis-US Rails Benefit From Fuel, Trucks Awaiting Recovery

For decades, trucks have been the undisputed choice of most companies for hauling freight long distances in the U.S. economy, carrying more than 80 percent of all goods.

But with oil prices at record levels and trucking costs so high, shippers are beginning to look to the railroads as a far cheaper, if less reliable, alternative.

"What we're seeing is the start of a modal shift," said Jason Seidl, an analyst at investment bank Dahlman Rose. "In the past, shippers have been reluctant to move freight to trains from the highway because they are slower and less reliable."

"But the price differential is now so wide that they are reexamining trains as an option," he added.

"We're looking at the trucking sector being a 2009 recovery story at this point," said Lee Klaskow, an analyst at Longbow Research. "We're being more conservative on these stocks until it looks like the U.S. economy is on firmer ground."

Once that happens, truckers that survive the downturn will be able to charge more as demand recovers, even if oil prices remain high.

While the price of oil has tailed off since last Friday's all-time peak of $147.27, it is still about double what it was a year ago.

That hurts truckers, especially when combined with weak demand thanks to sluggish retail sales, a home construction slump and the worst U.S. auto sales in a decade.

As rail officials never tire of pointing out, trains only use around a third of the fuel it takes trucks to move the same freight. This makes them attractive to shippers hurt by the fuel surcharges transport companies have imposed because of higher oil prices.

Trend toward Intermodal

Analysts say this week's second-quarter results from U.S. trucking company JB Hunt Transport Services Inc and railroad CSX Corp (nyse: CSX - news - people ) highlight this trend.

Truckload, or long-haul truck firm, JB Hunt reported a higher-than-expected profit, thanks to a 28 percent jump in intermodal revenue. Intermodal services use standardized containers -- holding consumer or finished goods -- that can be hauled by ship, truck or train.

In a statement JB Hunt said using intermodal to send goods by train had "allowed our customers to partially mitigate the impact of historically higher fuel prices."

The company also said it had reduced its truck fleet by nearly 11 percent over the previous year because of declining business at one of its two trucking divisions.

"We believe much of the trend toward intermodal has been aided by high fuel costs, which have made intermodal considerably more cost effective," Wachovia (nyse: WB - news - people ) analyst Justin Yagerman wrote in a note for clients.

CSX reported a higher net profit this week despite a 3 percent decline in freight volume but said domestic intermodal shipments were up 12 percent on the year.

Analysts expect the other major railroads -- Union Pacific Corp (nyse: UNP - news - people ), Burlington Northern Santa Fe Corp (nyse: BNI - news - people ) and Norfolk Southern Corp (nyse: NSC - news - people ) -- to post solid results next week thanks to strong pricing, despite disruptions caused by major flooding in the Midwest that primarily affected Union Pacific and BNSF.

The railroads have all maintained pricing power in recent quarters, even though freight volumes have declined, because capacity is still relatively tight.

Trucking companies, however, are not expected to report stellar results.

"None of the big trucking companies are at risk of going under," Dahlman's Seidl said. "But in the short-term we're going to see some challenged results on the truckload side."

Analysts have predicted that falling demand would push weak truck firms out of the market and the remaining companies would benefit because that would aid the supply-and-demand equation.

Some 1,000 small U.S. truck companies went bust in the first quarter and two larger firms -- Delano, New Jersey-based Jevic Transportation Inc and Kalamazoo, Michigan-based Alvan Motor Freight Inc -- shut up shop in the second quarter.

The disappearance of these trucking firms has reduced competition for the remaining truckers, but there has been little uptick in demand. And with the economy continuing to look shaky, conditions may not improve soon.

"(G)iven general economic pressures, we now believe industry demand will ramp more slowly than our original expectations and consequently are taking a more conservative view of 2009 for our coverage universe," R.W. Baird & Co analyst Jon Langenfeld wrote in a research note.

Trucking firms are on the U.S. economy's front line. When things go bad, they suffer first, but when recovery comes they are among the first to benefit.

Analysts said that when the economy does eventually pick up, truck demand will outstrip supply, allowing trucking companies to increase their rates.

"When the U.S. economy recovers the truckers will have pricing power like the railroads do today," Longbow's Klaskow said.