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— by Toby Kolstad
"Uncertain" is the best word to describe the current outlook for rail cars and railroad traffic, and indeed for the whole U.S. economy: There are more questions than answers for rail car forecasters. Will we have a double-dip recession that will depress demand for new rail cars? Will coal traffic recover next year if natural gas prices rise and lift demand for new rail cars? Will environmentalists succeed in blocking developments in the oil and gas industry, and thereby stifle rail shipments of hydrofracking sand and crude oil? Will this same group succeed in blocking the export of coal from West Coast ports? Will demand for new automobiles keep increasing, raising rail shipments of steel, light vehicles and auto parts?
For now, forecasters attempting to answer these questions must rely more on their political philosophy than financial facts, and political philosophy can be a poor guide absent any clear market trends or reliable financial indicators.
The uncertainty is manifested in the stock prices of railroad companies and rail-car builders; today's "good news" is being steeply discounted in expectation of falling rail traffic and declining orders for new rail cars in the not-too-distant future. The steady rise of railroad intermodal traffic should be signaling a strong economy with good prospects for growth in the future, but investors seem to be focused on the loss of coal and grain traffic — and the long-term effect the loss of this business may have on railroad revenue. For rail-car builders, order and delivery rates likewise indicate strong profits in future quarters, but investors seem wary, even though backlogged orders could extend production into second-half 2013 at current production rates.
In the leasing industry, utilization rates for rental cars are climbing, as are monthly lease rates on existing cars. Lease rates for new cars are also rising due to the inexorable increase in rail-car prices.
Meanwhile, lease terms for all rail cars are getting longer, with many new car leases qualifying for treatment as finance leases. One possible reason for the longer terms may be the economic uncertainty. Operating lessors may want to protect themselves in case of a downturn in business. It is more likely, however, that the increased lease periods are related to the types of cars being built today, such as petroleum tank cars, and the worry that they will not be needed if pipelines are laid in the future. A trend away from short-term operating leases to long-term finance leases — which have much lower monthly rates — is not yet apparent for most car types, possibly because the car types that are most commonly involved in operating leases (coal cars and grain covered hopper cars) are not currently in high demand.
Ironically, rail-car users seem to be dismissing the uncertainties relating to today's interest rates and rail-car prices, both of which may be considered low in the future if inflation drives up the cost of capital and price of steel. Although aging fleets will need to be replaced at some point, most car buyers and lessees are looking at the short-term economic outlook to guide their acquisitions. In just the last few years, new rail-car prices have jumped 15 percent; if history is any guide, they almost certainly will increase and drive rail-car prices even higher just as cars built in the 1970s need to be replaced.
One day, car replacement needs will be the main driver of new car orders as the building boom in the 1970s and the dearth of deliveries in the 1980s is reflected in another massive wave of rail-car deliveries. When that reflective wave in car building will start is still in doubt, but the longer car owners and users wait, the swifter the increase in orders and the higher the peak in deliveries will be.
The recent bump in demand for new box cars and mill gondola cars could be an early indication that car retirements will be starting soon. At the moment, about all that can be said is that it is a definite maybe.
Toby Kolstad has been in the railroad industry for more than 30 years, with stints at the Illinois Central Gulf Railroad, Denver & Rio Grande Western Railroad, a car builder and lessor. Currently a consultant on rail-car matters and president of Rail Theory Forecasts L.L.C., he can be emailed at Tkolstad@aol.com.