Obama’s Infrastructure Stimulus

The transition team of President-Elect Barack Obama is publicly discussing a stimulus package costing around $500 billion. The hope is that spending will stop deflationary pressures by having deficit-funded government spending offset spending cuts by consumers in retreat.

That equates to 3.5% of U.S. GDP, according to UBS economists. While I am skeptical that our elected officials can manage such an ambitious undertaking in a thoughtful, efficient and rapid way, the fact remains that spending of this magnitude, however bungled its distribution might be, will have a profound impact.

More details are beginning to trickle out on exactly which areas of the economy stand to benefit, as time appears to be of the essence in getting things done. Big infrastructures are by nature slow moving due to planning, permitting, and environmental review processes. Many economists fear that the economy will crash in the interim.

Infrastructure Projects Ready to Go

Earlier this week, with Obama pushing a “use it, or lose it” mantra, the nation’s mayors released a lengthy 803-page “Ready to Go” report in which 427 cities identified a total of 11,391 infrastructure projects worth $73 billion that could start within two calendar years. A previous version of the report showed 4,645 projects in 154 cities, so the list will surely grow as more municipalities are surveyed.

It’s like a Christmas Wish List for mayors, with projects slotted into 10 categories, such as road, water, community development, transit, and energy.

Here in my hometown of Seattle some $50 million is allocated to widening Mercer Street, a major arterial that frequently backs up onto Interstate 5 and is a major safety concern. Another $7 million is aimed at installing solar panels on Qwest Field, the home of the Seahawks. Even small projects, like the $150,000 allocated for a solar hot water heater in the Seattle Aquarium, are listed. Many are controversial. I noticed a $43-million storm drain system near my house which has been the subject of neighborhood battles for years.

Hitting the whole list would spiff America up right nice, and it will require lots of heavy machinery, materials, and manpower. Like most government projects, however, expectations for success are probably at their apex right around now.

Railroads on Track?

Moving heavy loads of asphalt, timber, and piping falls on the transportation sector. The industry is already attracting investor attention since it’s historically outperformed during recessions and the early stages of recoveries. Now, as freight volumes increase to support the projects the mayors identified, the effect should be even more pronounced.

This should be great news for the railroads in particular. Recent reports from the rail yards show declining carloads as import/export activity drops off a cliff. With a reduced need to haul Chinese goods inland from the ports, or coal from the Rocky Mountain west to the Atlantic seaboard, train engines are pulling lighter loads.

Downtime a Good Thing

On a positive note the railroad companies, such as Union Pacific (UNP), are using the downtime to improve their service quality and efficiency, all of which will boost profitability when freight volumes return to more normal levels.

Credit Suisse analyst Christopher Ceraso notes that train speeds are moving up while terminal dwell hours are moving down. These efforts allowed Union Pacific to increase average revenue per car by 22% in the third quarter, even as carload volume declined 5%.

Railroads Not Immune

Capacity cutbacks at railroads are already well under way, with companies storing unused railcars and shipping companies anchoring ships as import and export volumes plummet around the world. Here in the United States, the Department of Commerce today released trade data for the month of October. It’s not pretty: Exports of goods fell $3 billion to $105 billion, while imports fell $2.7 billion to $175 billion. The data for November will likely be much worse as a reflection of deepening financial crisis and consumer spending slowdown.

To better predict just where freight volumes are going, a group of Credit Suisse analysts have created a forecast model that relies on exports, business and residential fixed investment, personal consumption, industrial production, and real interest rates. Whereas in October the model was predicting freight tonnage to decline 3% next year, deteriorating conditions have since caused the model’s forecasts to plunge 8%.

Running Down the Rails

Fortunately, much of this negativity has already been priced into the transportation sector. What you need to understand is that different modes of hauling freight have different exposures to the economy. Airfreight and less-than-truckload companies perform poorly in the type of consumer-driven freight volume contraction we are now witnessing. Railroads, however, haul mostly commodities and raw materials instead of finished products, and therefore have less exposure to fluctuations in consumer spending.

This characteristic should allow the railroads to weather the current downtown better than peers while taking maximum advantage of the infrastructure spending that will be launched in the spring or summer.

One big concern I do have concerns the importance of the coal industry to the long-term health of the railroads. Roughly 44% of total railroad tonnage hauled each year is coal moving out of mines in the surrounding the Rocky and Appalachian Mountains towards populations center in the Midwest and Atlantic Seaboard. Should the Obama administration move to severely curtail the construction of new coal-fired power plants, railroad shares would be in trouble.

Offsetting this risk somewhat is the reality that the United States is well endowed with coal, providing an incentive for policymakers, researchers, and the power industry to find a way to burn it cleanly through coal-to-gas, coal-to-liquids, and carbon capture and sequestration technologies.

Union Pacific Well-Positioned

Union Pacific would then be well positioned, given its railway proximity to low-sulfur coal deposits in the Powder River Basin in Wyoming, and area of intense development by coal miners.

UNP has fallen below its November lows as fears of economic collapse rise, making it among cheapest big industrial stocks. Ultimately it will also be one of the first to rebound whenever the mood shifts toward optimism. Keep an eye on it. See ideas like this and more in Trader’s Advantage.

This article was written by Jon Markman, contributor to InvestorPlace Media. For more actionable insights likes this, visit www.InvestorPlace.com.