Will exports replace domestic demand as the fuel for Canadian railroads in 2014?

The rail companies Canadian Pacific and Canadian National have now reported their 2013 financial results in the year that saw rail volumes finally surpass 2007 levels with 2.86% growth. According to the Association of American Railroads, increases in Canadian rail volumes encompassed virtually every segment, with the only declines registered by agriculture, metallic ores and automotive at -2.5%, -1.1% and -4.5% respectively. While growth was broad based the most significant figures were found in the chemical segment, which accounted for 13.5% of 2013 traffic and recorded a 9.8% growth rate, and intermodal which grew by 4.5% off the back of domestic demand. In 2013 intermodal freight made up 40.59% of Canadian rail traffic. The rewards of these rising volumes were reaped by both Canadian Pacific and Canadian National, with revenues rising by 7% and 6.6% respectively.

These figures were driven by the steadily improving Canadian economy which was estimated by the Bank of Canada to have grown by 1.6% in 2013, fuelled by strong demand from consumers, itself supported by inflation that remained as low as 1.3% for 18 months. However, in spite of favourable conditions south of the border, the weakening Canadian Dollar has been unable to stimulate strong export growth to the US. Fortunately for the Canadian railroads domestic demand was robust enough to generate and sustain the increasing volumes, at higher freight rates, that have resulted in solid revenue growth for both Canadian Pacific and Canadian National. With the outlook for both companies already looking positive, the promise of exports returning to normal levels must be an enticing prospect for rail operators.

In the midst of these economic environs Canadian National was able to achieve revenue growth of 6.6% during 2013, bringing the companies full year revenue figure up to C$10.58bn. The rail company also recorded a rise in EBITDA to C$4.85bn, an increase of 5.2% on 2012, producing a healthy margin of 45.9%. These increases can be attributed to growth across almost every segment, notably of 20% in petroleum and chemicals, and to increased freight rates.

Meanwhile, Canadian Pacific Railway reported revenue of C$6.1bn in 2013, an increase of 7% on the prior year. Alongside this the company reported EBITDA of C$2.4bn, up by 30.3% compared to 2012’s figure, accordingly the company’s margin increased by 21.3% to 39.3%. In profit terms Canadian Pacific fell markedly short of the standard set by Canadian National, however many of structural changes made by Canadian Pacific in 2013 will help to narrow that gap over 2014. Perhaps the greater concern of Canadian Pacific should be its falling market share in one of rail transports highest growth areas, intermodal. If this trend continues the company is liable to miss out on substantial profit making opportunities in the future, especially with intermodal by rail likely to benefit from export growth in the medium term.

While the Canadian railroads are subject to many of the same pressures and influences as their US counterparts they are, in many ways, in a much stronger position. The sources of growth for the Canadian railroads’ volumes are more diverse and diffuse than those found in the US. While in the US the decline of coal, which accounts for 39.5% of rail traffic, is likely to have a manageable but damaging effect, in Canada the fossil fuel accounts for just 11.6% of rail traffic and indeed was stable in 2013. Moreover, Canadian National views coal as a potential growth segment, seeing the rise of metallurgical coal/ coke in Canada, and coal production in the Illinois Basin, as likely sources of revenue in the future. It is therefore apparent that Canadian rail is less vulnerable to fluctuations in individual segment volumes than its US cousin.

The greater variation and broader growth in the Canadian railroads’ volumes leaves them well placed to avoid some of the more troublesome issues facing US rail freight. In fact both Canadian Pacific’s and Canadian National’s operations in the US offer the chance to take advantage of opportunities there. With the US economy getting back into gear, and the prospect of the value of Canadian Dollar slipping as low as 85 US cents, it seems Canadian exports, which are currently resting some way below the level reached prior to the financial crisis, hold the greatest potential for further growth for the Canadian railroads.