Transportation is the linchpin of any economy. And the bigger the country, the more critical to well being are its roads, railways and airline routes.

The traffic on a country’s transport network is also one of the best barometers of its economic health. Transportation modes and infrastructure provide critical links at all stages and all geographic scales in the production-consumption cycle. When more goods are moving via the transportation network, it’s a sign that economic conditions are improving.

That fact certainly wasn’t lost on Charles Dow and his stat geeks when they started tracking transportation stocks in the Dow Jones Transportation Index more than a century ago. That was in fact a dozen years before the foundation of the Dow Jones Industrial Average.

Like the US, Canada is a big country with far-flung markets and many miles in between. Its transportation network includes 870,000 miles (1.4 million kilometers) of roads; 10 major international airports and 300 smaller airports; 44,797 miles (72,093 kilometers) of functioning railway track; and more than 300 commercial ports and harbors serving the Pacific, Atlantic and Arctic oceans, the Great Lakes and the Saint Lawrence Seaway.

It also includes a vast and growing web of pipelines: According to the Canadian Energy Pipeline Association, there are 360,395 miles (580,000 kilometers) of pipeline in Canada, transferring oil and natural gas to various locations within the country, North America, and to ports, where products can then be shipped globally. That web transports some 2.65 million barrels of crude oil and equivalent per day, as well as 17.1 billion cubic feet of natural gas per day travel.

A few more statistics convey the importance of Canada’s transportation network. As of February 2010, transportation and warehousing accounted for 4.7 percent of Canadian GDP, compared to 21 percent for finance and insurance, 13 percent for manufacturing, and 4.2 percent for mining and oil and gas extraction.

So what is the data telling us now about Canadian transports, and the country’s economic health? Mainly, that the recession is over. And while business is coming back only slowly, sector leaders are gathering strength. That’s why Canadian Edge Conservative Holding TransForce (TSX: TFI, OTC: TFIFF) is up more than 26 percent this year, versus a flat to down performance by other major indexes on both sides of the border. And it’s why TransForce and other strong industry companies are headed for even bigger profits ahead.

Riding the Rails

Let’s look at the numbers. One of the best measures of freight traffic is the Association of American Railroads’ (AAR) weekly “railcar loadings” data, a highly useful, real-time gauge of the health of several sectors as well as the economy as a whole.

Data are updated by the AAR every Thursday and detail the numbers of railcars loaded by major North American railroads. The bottom line figure reveals whether a railroad is shipping more, less or similar quantities over time.

US railroads originated 295,718 carloads during the week ended May 1, 2010, up 16.3 percent from the comparable week in 2009. Intermodal traffic totaled 213,013 trailers and containers, up 13.2 percent from last year but down 5.4 percent compared with 2008.

Compared with the same week in 2009, container volume increased 15.2 percent while trailer volume gained 3.2 percent. Compared with the same week in 2008, container volume was up 2.3 percent while trailer volume fell 33 percent.

Total volume was estimated at 32.9 billion ton-miles, up 16.7 percent from last year but down 6.5 percent from 2008. Carload volume was up 22.3 percent from last year in the East, but down 13.1 percent from 2008. In the West, carload volume was up 12.5 percent from last year but down 10.6 percent from two years ago.

Gains in carload freight were led by a 333.1 percent jump in metallic ore loadings. Loadings of metals were up 109.2 percent, scrap was up 67 percent and coke gained 43.8 percent. Other significant increases included motor vehicles, 25.8 percent; grain, 24.5 percent; lumber, 18 percent; crushed stone, sand & gravel, 13.9 percent; chemicals, 10.4 percent; and coal, 7.4 percent.

For the first 17 weeks of 2010, US railroads reported cumulative volume of 4,769,658 carloads, up 5.3 percent from 2009, but down 13.9 percent from 2008; 3,466,043 trailers or containers, up 9.8 percent from 2009, but down 8.1 percent from 2008, and total volume of an estimated 521.4 billion ton-miles, up 6.2 percent from 2009 but down 10.5 percent from 2008.

Those same positive trends are even more pronounced elsewhere on the continent. Combined North American rail volume for the first 17 weeks of 2010 on 13 reporting US, Canadian and Mexican railroads totaled 6,229,078 carloads, up 8.2 percent from last year, and 4,328,397 trailers and containers, up 10.2 percent from last year.

Most impressive, Canadian railroads reported volume of 75,285 cars for the week, up 29.4 percent from last year, and 47,236 trailers or containers, up 15 percent from 2009. For the first 17 weeks of 2010, Canadian railroads reported cumulative volume of 1,232,792 carloads, up 18.3 percent from last year, and 753,433 trailers or containers, up 9 percent from last year.

The most recent monthly data from Statistics Canada includes more detail on the composition of rail traffic north of the border. Cargo volume carried by Canadian railways increased in February, as both commodity loadings in Canada and traffic received from the US rose.

Total freight traffic originating in Canada and received from the US increased to 21.9 million metric tonnes in February, up 6.2 percent from February 2009. Freight loaded in Canada rose 5 percent compared to year-ago levels to 19.8 million metric tonnes in February. Non-intermodal and intermodal systems both contributed to the rise in cargo loaded.

Non-intermodal freight loadings, typically carried in bulk or loaded in box cars, rose 5.3 percent to 17.9 million metric tonnes. The commodity groups with the largest increases in tonnage were potash, coal, iron ores and concentrates, and iron and steel (primary or semi-finished).

In contrast, several commodity groups registered decreases. Leading the drop in tonnage was wheat, followed by wood pulp, fresh, chilled or dried vegetables and newsprint.

Intermodal freight loadings, transported through containers and trailers loaded onto flat cars increased 2.8 percent to 1.9 million metric tonnes in February, compared with the same month the previous year.

Rail freight traffic coming from the US rose to about 2.2 million metric tonnes, up 18.6 percent from February 2009. Both non-intermodal and intermodal freight transported from the US contributed to the increase.

From a geographic perspective, 58.1 percent of the freight traffic originating in Canada was from the Western Division, while the remainder was loaded in the Eastern Division. That’s in large part a consequence of Canada’s expanding trade with Asia, which has enabled the country to avoid much of the fallout from the US recession. StatsCan’s Eastern and Western divisions are created for statistical purposes by an imaginary line running from Thunder Bay to Armstrong, Ontario. Freight loaded at Thunder Bay is included in the Western Division while loadings at Armstrong are reported in the Eastern Division.

Results from two significant North American companies under CE coverage, TransForce and member of the How They Rate Transports universe Canadian National Railway (TSX: CNR, NYSE: CNI) and a couple from outside the CE coverage universe, low-cost air carrier WestJet Airlines (TSX: WJA, OTC: WJAFF) and Canadian Pacific Railway (TSX: CP, NYSE: CP)–confirm that more traffic–cargo and human–is moving through the continental network.

At a time when many investors are worried about a global double-dip recession, that’s clear evidence that Canada’s economy is moving in a considerably more positive direction. It’s also very good news for these companies, all of which are still trading at sizeable discounts to where they were before the 2008 crash.

In short, now’s a great time to step up to the plate and add some to your portfolio. Here’s our roundup of some of our favorites. Note that TransForce’s first quarter earnings are reviewed in further detail in the Portfolio Update section

Oil Sands by the Carload

Canadian National’s first-quarter report drew a mixed response from Bay Street analysts. The headline earnings number beat expectations, inspiring buy-target increases and quips to the effect that “it’s not too late to hop on the train.”

During the first quarter CN’s carload volume–its internal equivalent of railcar loadings–rose 16 percent. CN posted double-digit volume increases in metals and minerals, coal, automotive, Canadian grain and fertilizer.

Foreign demand for metallurgical coal, in particular, has kept CN busy; the railroad moved record coal volume from mine to vessel for shipment overseas in the first quarter. Strong volume trends continued into the second quarter, as carloads reached 90,000 in April for the first time since the fall of 2008.

Overall revenue grew 6 percent (17 percent adjusted for currency swings); automotive (48 percent), coal (28 percent), intermodal (10 percent), metals and minerals (6 percent) and grain and fertilizers (4 percent) generated increases. Revenues declined 6 percent for petroleum and chemicals, 5 percent for forest products.

CN’s operating ratio–operating expenses as a percentage of revenue–came down to 69.3 percent from 71.7 percent a year ago, well below the 80 percent considered desirable in the railroad industry.

Source: National Energy Board of Canada

On-the-rail results, as CEO Claude Mongeau noted in his remarks opening the company’s first-quarter conference call, also suggest Canada’s economy is growing faster than most observers anticipated. Based on the first 12 weeks of the year Canadian National, one of North America’s largest transportation companies, boosted its full-year cash flow guidance from CAD700 million to CAD1 billion.

More pipeline capacity is needed to transport oil sands production, a growing source of oil supply to the US and still an intriguing prospect for emerging Asian economies such as China, but construction is expensive and time-consuming. Into that perceived breach has stepped CN Rail. 

CN has proposed shipping oil sands production south to the US and west to British Columbia’s ports for eventual transpacific delivery; it still hasn’t drawn much attention as the energy exploration industry gets back up to speed following the series of shut-ins and cancellations that marked 2008 and 2009.

CN’s idea is promising; upgraded oil sands output or simple bitumen could be moved more economically than by pipeline–if can subsequently be exported to Asian markets. CN opened discussions with Alberta’s provincial government about its “Pipeline on Rails” more than a year and a half ago.

A feasibility study conducted on behalf of CN found that Canadian oil producers and their customers are paying CAD17.95 per barrel to ship oil from Alberta to US gulf coast refineries. Freight rates covering track and rolling stock expenses are forecast to be competitive with tolls for shipments on new pipelines from Fort McMurray to the Gulf Coast.

Any pipeline company would, of course, take issue with CN’s assertions. But until pipeline capacity is, in fact, expanded, CN management may be able to compete with existing pipelines on price while transporting up to 4 million barrels of oil a day. Affording cheaper access to the Gulf Coast as well as access to Canada’s west coast–for eventual shipment to California refineries or to Asia–means smaller producers will enjoy greater flexibility.

The estimated cost of building lines to ship 4 million barrels a day from the oil sands to the Gulf Coast is USD24.7 billion. A proposed increase in capacity to the west coast adding 600,000 barrels a day is another CAD4 billion. Such efforts would take years to complete.

Costs of restoring CN’s network to a condition that would support the Pipeline on Rails are estimated in the millions, not billions, of dollars. CN is offering deliveries via the old railway branch line between Edmonton and Fort McMurray, which it recently bought from short-haul specialists Athabasca Northern Railway and Lakeland & Waterways Railway.

The Pipeline on Rails is essentially new work on old track; with about CAD135 million in improvements to strengthen the line and its safety systems, heavy trains carrying diluted bitumen or synthetic crude will be able to average 40 kilometers an hour between Fort McMurray and Edmonton. The track could eventually be extended into the bitumen mining district north of Fort McMurray if industry demand merits such a step.

CN believes it can ship 300,000 to 400,000 barrels a day between Fort McMurray and Edmonton and has set a medium-term goal of up to a million barrels a day on the existing network. Eventually, CN hopes to move 4 million barrels.

The Pipeline on Rails will deliver oil sands production through the use of insulated and heatable railcars or by reducing its viscosity by mixing it with condensates or diluents. Scaling up to 4 million barrels is simply a matter of adding cars; current rail capacity is sufficient to handle such volumes.

Alberta and Saskatchewan now depend on the US as their export market. Efficient rail transport could provide immediate cash flow to producers that would otherwise have to wait for the completion of incredibly costly upgraders and/or pipelines–or simply shut in their wells.

Access to the west coast also means access to world markets; a 2004 National Energy Board report on the challenges and opportunities in the oil sands said the US historically has absorbed any additional production of crude oil from Canada. But it concluded that “additional markets will be required to keep pace with oil sands expansion.”

Should the oil sands-by-rail plan reach fruition, it will mean major business for the company. But even if it doesn’t, Canadian National is on track for substantial profit gains as the country’s resources increasingly find a market in the Far East. Buy Canadian National Railway up to UD60.

Canada’s No. 2 railroad outfit, Canadian Pacific Railway, has a similarly bullish road to growth. The company reported a 74 percent first-quarter profit surge, the bounce-back powered by effective cost-management, efficiency gains and increased traffic–volumes were up 1 percent sequentially, the third consecutive quarter of growth and confirmation that the trend for demand is positive.

The company will continue to focus on managing costs and driving productivity, which essentially means adding cars to existing trains to move more stuff to fewer locations. Total revenues were up 14 percent, while overall expenses increased just 3 percent (excluding foreign exchange impacts and fuel prices). CP generated CAD51 million of free cash flow for the quarter; management will pay down CAD350 million of debt due in June from its cash pile.

Interest expense declined 1 percent, while fuel expense was up 6 percent on rising volume and prices. Some operating expenses were actually helped by a stronger currency; materials costs declined by CAD13 million, for example. Cost management remains a concern, even as the company prepares for rising volumes over the balance of the 2010. The operating ratio improved 570 basis points from the first quarter of 2009 to 82.4 percent.

Carloads were up 8 percent year over year, each business group registering gains. RTMs (revenue ton miles) jumped 17 percent. In currency-adjusted terms, grain revenue was up 4 percent on a 2 percent increase in volume. Coal revenue increased 7 percent on strong demand from Chinese steel producers; total export volumes increased 30 percent year over year. Sulfur and fertilizers were up 78 percent; RTMs in this segment rose 101 percent as international buyers came back to the potash market to complement strong domestic demand. Merchandise revenue rose 23 percent, with volume up 14 percent.

Management expects a strong Canadian grain market for the balance of 2010; in the US conditions will largely mirror those of the second half of 2009, when a poor corn harvest left a lot of uncertainty about volumes.

As for coal, CP is basing its model on Teck Resources’ (TSX: TCK/B, NYSE: TCK) estimates of Chinese met coal imports, which it projects to remain strong, and thermal coal volume should steadily climb with industrial activity

Second-quarter fertilizer demand remains strong, but the view beyond is murkier. The company expects modest merchandise growth, led by a resurgent North American auto industry. Intermodal transport should post modest growth as the Canadian economy continues its strong rebound.

The comparisons are going to get tougher, but CP is on track to enjoy the global economic recovery. We’ll be adding Canadian Pacific Railway to How They Rate coverage in the next couple of weeks. Meanwhile, it draws a CE Safety Rating of 4 and is a buy up to USD60.

Top of Trucking

TransForce CEO Alain Bedard wasn’t as eager to hail the impact of economic recovery on his company’s results. Rather, he credited his company’s modest first-quarter improvement to “disciplined efforts to contain costs and increase efficiencies.”

TransForce, which operates in the less-than-truckload, truckload and package courier segments and also provides a range of logistics services to the oil and gas exploration industry, among others, reported first-quarter total revenues of CAD466.1 million, a 3 percent year-over-year increase from CAD452.4 million in the first quarter of 2009; excluding fuel surcharges revenue was up 2 percent, to CAD429.2 million from CAD422.2 million.

The acquisition of the retail business of ATS had a significant impact on results, basically turning what would have been a 3 percent revenue decline into a 3 percent increase.

Operating expenses rose in line with higher revenue, though the company continued to reduce its fixed costs and general and administrative expenses. Interest expense decreased to CAD8.4 million from CAD9.9 million a year earlier on lower rates and reduced debt.

Cash flow from operations increased 30 percent to CAD43.5 million from CAD33.3 million. Net income was CAD26.6 million (CAD0.28 per share), up from CAD3.1 million (CAD0.04 per share) in the first quarter of 2009. TransForce paid a dividend of CAD0.10 per share during the quarter.

Revenues declined by about 3 percent in three of its four operating segments. Parcels and courier grew 34 percent, mainly because of the ATS acquisition, which added CAD25.4 million to overall revenue. The firm noted increased activity in the western oil patch, Ontario’s automotive sector and retail, which accounts for 19 percent of its overall business.

Though Bedard admitted encouragement by the first quarter’s results, TransForce stuck with a largely cautious tone it set during its fourth-quarter and full-year 2009 call. In February management forecast 2010 would be “only slightly better” than 2009, with the back half of the year showing more improvement. Bedard reiterated that view with the first-quarter release.

“While we saw some signs of economic improvement in the first quarter, most of the improvement was due to the actions we have taken. We do not expect to see a sustained recovery or increased volumes for our industry until later in 2010,” said Bedard.

Management’s ability to cut costs while pursuing a growth-through-acquisitions strategy bodes well for the long-term sustainability of its dividend; TranForce currently yields around 4 percent after a healthy rally off its March 2009 low below USD3. Still a solid bet for conservative growth and income amid weak economic conditions, TransForce is poised for explosive growth as conditions improve. Buy TransForce up to our raised target of USD11.

Sky’s the Limit

Not surprisingly, air traffic freight and passenger volumes in the first quarter 2010 were still below pre-crisis levels. That’s a pretty clear sign at least this corner of the transportation universe is going to take a bit longer to recover fully.

Compared to first quarter 2008, the global passenger numbers are still down by 3 percent. Compared to first quarter 2007, numbers are up by 1.5 percent. Global numbers also hide major differences among the regions.

The two largest markets, Europe and North America, remain significantly behind volumes reached in 2007, particularly in the US domestic and the intra-European markets.

The good news is there are are definitely signs of improvement. Inventories are being replenished and global demand for goods is picking up, international freight in particular seems on track to full recovery.

The positive trend has been temporarily interrupted by the fallout from the volcanic eruption in Iceland, which will put a significant dent in air transporters’ April results. That’s particularly true in Europe. Canada, however, is now definitely on the road to recovery and it’s starting to show up in companies’ results as well.

We currently track one Canadian airline in How They Rate, Jazz Air Income Fund (TSX: JAZ-U, OTC: JAARF). The trust’s share price has staged a solid recovery since bottoming around USD2 in early 2009. Business, however, has remained very difficult, evidenced by the -40 percent dividend cut last August. That’s in large part due to the troubles of Jazz’ parent Air Canada, which continues to ring up losses and remains perilously close to bankruptcy.

Statements by CEO Joe Randell to the effect that Jazz should be able to hold its current distribution after converting to a corporation have been encouraging. So are the trust’s recent moves to expand operations globally, for example last month’s CAD15 million investment in a Uruguayan regional carrier. Unfortunately, there are just too many risks attached to Jazz’ 12 percent plus yield for me to rate it a buy. Hold Jazz Air Income Fund.

In contrast, WestJet Airlines is in relatively good health. A leader in the low-cost air travel movement and one of Canada’s most admired companies, the carrier flies to 68 cities in its North America/Caribbean network.

The company’s load factor reached a record 84 percent in April. Meanwhile, management announced plans to expand its flights to the West Indies and Mexican vacation spots to include service year-round. Load factor for the entire quarter was up to 82.3 percent compared to 80.6 percent at the same point in 2009. Capacity measured by available seat miles was up 7.9 percent. Revenue passenger miles were up 9.7 percent. Revenue was CAD619.8 million, while net income was CAD13.8 million.

Those are solid numbers in any environment but all the more so given the current economy. We’ll be picking up coverage of WestJet in How They Rate in the next couple of weeks. For now, this Southwest Airlines of Canada draws a CE Safety Rating of 3 and rates a buy up to USD13. Note WestJet does not pay a dividend.

By Water

Unlike the US, most of Canada’s internal waterways are seasonal in nature, with ice blocking them in the winter months. Nonetheless, with the Asia trade expanding rapidly ports are becoming an increasingly important part of the country’s transport networks.

Industry analyst MDS Transmodal forecasts that Trans-Pacific trade will grow 14 percent in 2010, even as Trans-Atlantic traffic remains stagnant. But if the first quarter figures are any indication, that may prove conservative as Asian economies suck down ever-larger amounts of Canadian resources.

Port shipments handled at 29 trading ports in South Korea in the first quarter of 2010 rose by 12.3 percent year over year from the same period a year before to 281 million tonnes.

Pyeongtaek Dangjin Port saw a 59 percent year-over-year increase on the back of Hyundai Steel’s operation, the Port of Busan and the Port of Gwangyang posted increases of 26.7 percent and 16.8 percent, respectively.

Cass Information Systems processes more than USD17.5 billion in annual freight payables. According to the company, “These volumes of data provide a statistically valid sampling ratio that can be used as an economic indicator of industrial shipment activity.” Cass’ monthly freight index is based upon its clients’ shipments.

Before Finance Minister Jim Flaherty put the kibosh on new income trust offerings, we covered several Canadian shipping and ocean going freight companies. All of these have since been acquired for sizeable gains, including cold storage firm Versacold in 2007.

That’s left Westshore Terminals Income Fund (TSX: WTE-U, OTC: WTSHF), which owns storage terminals for metallurgical coal on Canada’s west coast, as our lone representative.

The company–whose biggest customer is Teck Resources–reported solid first-quarter results, with revenue and cash flow basically flat with the prior year’s tallies.

Westshore’s distributions have been highly variable in recent years, mainly because of the sensitivity of cash flows to the price of met coal, which is used to manufacture steel.

The April quarterly distribution of 42 cents Canadian per unit, for example, is 75 percent higher than the first quarter payout a year ago, but down considerably from the CAD0.53 paid out in January 2009.

Management has reworked its contract with Teck to factor out some of this commodity price sensitivity. But investors should continue to expect volatility in the payout, which is somewhat indicated by the high yield of around 11 percent. The underlying business, however, is stable and offers growth potential as the Asia resource trade expands. Westshore Terminals Income Fund is a buy up to USD15.