U.S. railroad stocks find themselves with a unique problem: being too profitable

Over the years, U.S. railroad companies have prioritized investors at the expense of customers and employees. But now they find themselves with a unique problem: being too profitable.

In an effort to please investors…

… railroad companies have been aggressively cutting costs, raising prices and returning capital to investors. Operating margins for the five largest U.S. operators grew to 41% last year — up from 29% ten years ago (BBG). In the process, they’ve pissed off a lot of people…

• Customers are angry with high prices and poor service.
• Workers are worn out from the company’s focus on efficiency.

But investors are happy. Railroad stocks have done very well in the past decade. Union Pacific (NYSE:UNP) — the largest publicly traded railroad company globally — has been up 354% in the past 10 years, while the S&P 500 is up 240%. Union Pacific has also returned over $41B to investors via dividends and stock buybacks.

Railroad employees have had enough

Railroad companies have also been stuck negotiating with labor unions for over two years — freezing railroad worker salaries since 2019.

On Monday, three U.S. unions representing 15,000 rail employees reached a tentative agreement with rail companies — giving workers a 24% wage increase between 2020 and 2024 (a portion being retroactive).

All it took was a push from Biden’s emergency board in August to end a stalemate between railroad companies and unions.

• Still, unions representing another 100,000+ workers are under negotiations.
• Unless they reach an agreement, workers could legally go on strike in September — adding even more pressure to supply chains.

Increasing wages will add pressure to the profitability of railroad companies.

Investors: Lose-lose scenario

According to Bloomberg columnist Thomas Black, railroad companies have backed themselves into a corner — faced with two options, and neither are attractive to investors:

1. Cut costs even more and risk upsetting their customers and employees further.
2. Take business from trucking — which is difficult without improving operations, a move that would lower profitability.

In the second case, railroad stocks would “likely get hammered” if growth plans involved lowering profitability. But they’ll lose investor interest if they don’t figure out a way to grow.

Railroad companies have found themselves in a tough spot that could derail a tremendous decade-long performance.