Infrastructure Fuels J. B. Hunt Intermodal

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In the game of Monopoly, the more railroads you own, the more money you make.

Though it’s a boring strategy in the classic Parker Brothers game, it’s been a sound plan on Wall Street so far in 2008.

While real estate markets from Baltic Avenue to Boardwalk have been tanking in the current credit climate, railroads have been outperforming their peers in the S&P industrials index.

Nearly 139 years after the Golden Spike was driven in the transcontinental railroad linking the east and west coasts, the rail industry continues to enjoy a sustained renaissance with origins that lie in the landmark intermodal joint-services deal reached in 1989 between Burlington Northern Santa Fe and Lowell’s J.B. Hunt Transport Services Inc.

Leading rail companies have invested $10 billion in infrastructure improvements and expansions since 2002 and have announced plans for at least $12 billion more over the next few years. The U.S. Department of Transportation expects freight volume to increase by 88 percent to 37.2 billion tons by 2035 on more than 52,000 miles of the nation’s main rail corridors.

“You have to pat the railroads on the back,” said J.B. Hunt intermodal president and chief marketing officer Paul Bergant. “They have done a great job improving their part of the operation. We also have to pat ourselves on the back. Coming from a pickup and delivery background, the advent of J.B. Hunt has really improved that precious piece of the intermodal puzzle.

“We’ve provided consistent and competitive service on both ends, which along with the railroads’ improvements has made a much better product.”

Year-to-date, J.B. Hunt’s chief rail partners, BNSF and Norfolk Southern (which handle 95 percent of the company’s intermodal volume), are up by a respective 9 percent and 10 percent with the broader rail index up around 8 percent.

J.B. Hunt’s share price has advanced 25 percent over the same period, closing just off its 52-week high at $33.10 on April 1.

Union Pacific, whose roots reach back to that historic date of May 10, 1869, has returned more than 32 percent since January 2007 and Warren Buffet’s Berkshire Hathaway owns an 18 percent stake in BNSF worth nearly $6 billion.

Following the agreement between BNSF and J.B. Hunt, rail freight volume has increased by an annual rate of 3.6 percent from 1990-2002, according to the Government Accountability Office, gobbling up the excess capacity built following industry deregulation in 1980 and spawning a free-market model now imitated around the world.

Vision Realized

Back in 1990, the late company founder J.B. Hunt and then-BNSF president Michael Haverty spoke enthusiastically about $90 million in new business thanks to the deal.

The two have rightly been declared visionaries in the two decades since.

BNSF’s operating revenue has skyrocketed 21.7 percent in the last three years, growing from $12.98 billion in 2005 to $15.8 billion in 2007.

Since 2000, J.B. Hunt’s operating revenue from its intermodal division has leaped 142 percent from $681.1 million to $1.6 billion in 2007.

Over the same period, J.B. Hunt’s over-the-road trucking revenue has advanced less than 1 percent, from $833.8 million to $841.7 million.

High diesel prices and a slowing economy in 2007 reduced its OTR revenue by 12.8 percent from 2006. Meanwhile, intermodal revenue increased 15.6 percent, just above its average annual growth rate of 13.5 percent since 2000.

Not only has intermodal been J.B. Hunt’s largest source of operating revenue since 2003, when it first surpassed the trucking division, it is also easily the most profitable.

Intermodal represented 47 percent of J.B. Hunt’s total 2007 revenue but accounted for 65 percent of its net income, or $239 million.

Bergant, an executive at the company for 30 years and the president of intermodal since 2004, said despite its trucking history, J.B. Hunt’s indifference to the OTR model is what allows it to excel at intermodal.

“We’ve never had a truck or intermodal preference and that continues today,” Bergant said. “A lot of competitors have tried to imitate it, but they still have a foot stuck in the trucking world.”
 

Sustainable Growth

A study commissioned by the American Association of Railroads released last September estimates the cost in 2007 dollars of making the necessary improvements to rail infrastructure by 2035 at more than $148 billion.

The share to be borne by the Class I railroads is $135 billion, of which they estimate $96 billion will be paid for by growth in revenue, higher volume and productivity improvements.

Improvements range from simple maintenance to laying parallel tracks to heightening tunnels on east coast routes to allow for double-stacking rail cars.

Norfolk Southern handles most of J.B. Hunt’s east coast intermodal freight and as west coast ports like Long Beach continue to be backed up with a flood of Asian-made goods, their counterparts on the Atlantic are seeing an increase in volume.

“Long Beach isn’t declining, but some of that import growth has shifted to the east,” Bergant said.

The rise of east coast port and intermodal volume is one reason why Bergant can confidently predict operating revenue from the division will continue to grow at “high single-digit, low double-digit” rates.

“That’s doable, that’s sustainable,” he said.

In the early- to mid-1990s, Bergant said, west-coast partner BNSF built four state-of-the-art terminals that allowed intermodal volume to grow without exceeding capacity at what can be the chokepoint for freight.

“They did a great job staying ahead of the curve,” he said.

Infrastructure expansions aren’t the only thing contributing to intermodal growth. With diesel prices surpassing $4 per gallon, the independent trucker is an endangered species and Bergant said 50 percent of intermodal growth in 2008 will be over traditional short-length OTR trips of 650 miles to 1,200 miles.

“We are pegging our current plan and future plans on more and more truck conversion,” he said.

The cost-effectiveness of a transcontinental haul is obvious with rails averaging three to four times the fuel efficiency of trucks, but diesel has become so expensive that benefits now apply to short hauls.

According to the AAR, in 1980 rail could move a ton of freight 253 miles on a gallon of fuel. By 2006, that number improved 80 percent to 423 miles per ton per gallon.

The AAR notes that if an additional 10 percent of truck volume were shifted to intermodal, the annual savings would top 1 billion gallons of fuel.

Bergant said J.B. Hunt’s fuel surcharges are 50 percent less for intermodal versus OTR and the base cost is 10 percent to 15 percent less as well.

The US DOT estimates that increasing highway congestion costs the economy $63.1 billion per year, and clogs across all modes of transportation may be as high as $200 billion.

That congestion is contributing to the increase in logistics costs that began in 2004, reversing a downward trend over the previous 23 years. As a percent of GDP, logistics costs have increased from a 25-year low of 8.6 percent in 2003 to 9.9 percent in 2006. Logistics were 16 percent of GDP in 1980.

“It’s not often you can find ways to reduce logistics costs on short hauls, but converting from truck to rail is one of those great opportunities,” Bergant said. “It makes a lot of sense and at the end of the day, what makes sense is what’s going to work.”