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By Jeremy Glaser | 05-05-2011 06:09 PM

Values in Railroad Bonds?

Railroads have seen remarkable margin improvement since the rail renaissance began, and we see some select opportunities amid the sector's bonds.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. Are there values in railroad bonds? I am here today with Keith Schoonmaker and Jeff Cannon to take a look at the industry and see where fixed income investors should set their gaze. Gentlemen, thanks for joining me.

Jeff Cannon: Thank you.

Keith Schoonmaker: Thank you, Jeremy.

Glaser: So Keith, can you give us a general overview of how the railroad industry is doing. Has the recovery really caught up to them? Are they doing well?

Schoonmaker: Sure, I will be glad to Jeremy. Let me comment briefly on volume recovery, and on profitability performance of the railroad.

First on volume, we saw volumes fall off precipitously in 2009, when both carloads and intermodal volume both sunk about 15%. In 2010, we saw carloads recover about 9% and intermodal back up about 15%. But coal gained just 2% that year, after losing more than 10% in 2009. Now this year-to-date we've seen carloads up an additional 3.3% and intermodal up 7.9%, coal up by just a little bit 2.4%, year-to-date. Looking forward, we expect volume to continue to recover long run at low single-digit pace.

Now, as far as profitability, that's a different story. The rails have performance just exquisitely throughout 2009, 2010, and to-date, setting new records and many rails for example Union Pacific, CSX, Kansas City Southern, all achieved record profitability in 2010 and also first quarter profitability in 2011, and as a whole we've seen the industry go from operating ratio, that is operating expense over revenue, so lower number is more desirable, and indicates better performance. We've seen the industry as a whole go from about mid-80s performance to low 70s performance in the past 10 years or so. So, it's really been a remarkable margin improvement story for rails since rail renaissance began.

Glaser: So, in light of this recovery Jeff, I know that you've taken a look at some of the credit metrics and credit worthiness of the railroads. Can you give us an overview of where your ratings shook out?

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