A bold play to shake up the North American railroad industry ran out of track on April 11, when Canadian Pacific Railway withdrew its unsolicited $28 billion bid for rival Norfolk Southern Corp. Spearheaded by CP chief executive E. Hunter Harrison and activist investor William Ackman, the planned deal would have been the first merger of two Class 1 North American freight railroads since 2001.

But the management and board of the Norfolk, Virginiabased target had refused to talk. After three rebuffs and a proxy filing aimed at forcing merger negotiations by a shareholder vote, Calgary-headquartered CP saw no clear path to a friendly merger at this time, Harrison said in a statement.

CP investors were happy with the outcome: The companys stock closed at C$187.65 ($145) on April 15, up 6.2 percent for the year. Politicians, rail customers and trade unions opposed the deal, which would have reduced the number of Class 1 railroads from seven to six, fearing job losses and higher freight costs. For its part, CP has asked the U.S. Department of Justice to investigate what it calls anticompetitive efforts by some of its peers to block the Norfolk Southern merger.

Harrison and CP board member Ackman, founder and CEO of hedge fund firm Pershing Square Capital Management, had big dreams for the tie-up: the continents third-largest railroad, stretching from Vancouver to Miami. To fulfill its East Coast ambitions, CP could yet swallow bigger competitor CSX Corp., but the Jacksonville, Floridabased company reportedly spurned a $20 billion offer, making that prospect unlikely.

With mergers unpopular in many quarters, the North American railroad industry finds itself at a crossing, searching for new growth engines. The commodities rout, in particular the steep decline of coal, has cut deeply into traffic volume. But railroad bosses  and bullish investors, including billionaire Warren Buffett  see light at the end of the tunnel.

For shareholders, who had been accustomed to steady growth before it ground to a halt in the first quarter of last year, the ride may continue to be bumpy. After 15 years of relative outperformance, what we see now is a return to cyclicality with volumes but not pricing or margin improvement, says Ken Hoexter, a New Yorkbased transportation analyst at Bank of America Merrill Lynch.

The glory days are over, Hoexter warns. The new normal for railroads means earnings-per-share growth in low two digits to mid teens, versus peak returns north of 25 percent between 2003 and 2014, he says.

Until last year railroad revenue kept climbing, propelled by strong global appetite for commodities, favorable pricing and leaps in efficiency. Then growth hit a major snag. Coal shipments, which accounted for 39 percent of all U.S. carloads and 18 percent of U.S. railroad profits in 2014, according to the Washington-based Association of American Railroads (AAR), went into sharp decline.

Factors ranging from tougher environmental rules for power plants to cheap shale gas and weak Chinese demand have hammered the coal business. U.S. production will shrink to 752.5 million metric tons this year, the U.S. Energy Information Administration forecasts, a 31 percent drop from 2011. On April 13, St. Louisbased Peabody Energy Corp., the top American coal miner, filed for Chapter 11, joining fellow publicly traded giants such as Alpha Natural Resources and Arch Coal in bankruptcy protection.

Railroads have felt the pinch. In the first quarter, total carloads for U.S. carriers fell 13.8 percent year-over-year, the AAR reports. Coal shipments led the way, with a 32.5 percent decline; petroleum products and ores and metals were down 20.9 percent and 9.8 percent, respectively.

We think that fossil fuels are probably dead, Harrison, a straight-talking Tennessean, said in March at a J.P. Morgan transportation conference in New York. Its going to take a long time to transition.

Still, railroads are faring better than the commodities producers whose goods they haul. Last year CPs adjusted diluted earnings per share climbed to a record C$10.10, a 19 percent increase over C$8.50 in 2014. Revenue also set a record, edging up to C$6.71 billion from C$6.62 billion in 2014. On April 15, CSX stock closed at $25.93, flat for the year and up 18 percent since May 2011. By contrast, the Market Vectors Coal ETF finished the day at $8.18, down some 80 percent during the same period.

As freight trains head into unfamiliar territory, will new sources of revenue spur growth and hike returns? Not without a fundamental, quantum shift in railway operations, CP president and COO Keith Creel tells Institutional Investor, citing precision scheduling and single tracking, whereby trains going both ways share the same track.

Different cargo will travel by rail within five years, experts say. The revenue portfolio is going to look dramatically different, predicts Frank Lonegro, CFO of CSX. Railroads are pinning their hopes on the intermodal business, the integration of trucks and trains on routes that trucks alone now dominate. The plan is for faster trains that will replace coal and other slow-moving commodities with on-time delivery of consumer goods.

From Montreal to Fort Worth, Texas, railroad executives are keeping their eyes on head count. Labor is our largest cost, Lonegro says. In five to ten years, well move to less labor intensity, from two to one person in a cab, and maybe in my lifetime to zero. In Australia some trains already run by remote control, he notes.

Before Harrison took charge in 2012, after heading Canadian National Railway Co. for seven years, CP paid too much for too little, according to Creel: People would effectively come in six hours for 12 hours of pay. After punching out theyd go to second jobs. The upshot? We dont need as many people, Creel says. In 2015, en route to a Spartan operating ratio  the railway industrys proxy for operating margin  CP trimmed its workforce by 12 percent, shedding 1,800 employees. Known as a ruthless cost cutter, Harrison expects to slash another 1,000 jobs this year.

In a world distracted by Facebook and iPhones, the sheer scale and power of freight trains still inspires awe. A single diesel locomotive can weigh up to 200 tons. In North Baltimore, Ohio, the CSX Northwest Ohio Intermodal Terminal spans 500 acres with some 35 miles of track. The terminal assembles 33 trains every day, using seven massive cranes that can lift 46 tons each. Its just one node in a CSX network that serves nearly two thirds of the U.S. population and 60 percent of the nations manufacturing base.

Railroads get into your blood, says CSXs Lonegro, whose company has its origins in the legendary Baltimore and Ohio Railroad, which began operating in 1830.

Almost 200 years of history, and an outsize role in the shaping of a continent, help to explain that attraction. Without railroads, the United States today would, in all probability, not be radically different from the United States of a hundred years ago, wrote Edward Hungerford in The Modern Railroad. That landmark history was published in 1911, five years before North American route mileage peaked at 254,000.

For most of the 20th century, dozens of railroads crisscrossed North America. Class 1 operations had colorful nicknames describing their local provenance: The Boston & Maine was known as the Route of the Minute Man, the Nashville, Chattanooga and St. Louis was dubbed the Dixie Line, and the Western Pacific was called the Feather River Route. Burlington Northerns moniker  the Wests First Mega Railroad  foreshadowed changes ahead.

In 1960, North America was home to 106 Class 1 railroads and less than 160,000 route miles of track. The Staggers Rail Act of 1980 loosened regulation of the industry, triggering a wave of consolidation. There were just seven major North American railways by 2001, when the U.S. Surface Transportation Board began requiring companies that wished to merge to prove the deal was in the public interest. This rule remains untested by players such as CP, which didnt make a formal merger application to the STB.

Three duopolies have ruled the rails in North America since 1999, when CSX and Norfolk Southern divided the assets of the Consolidated Rail Corp., better known as Conrail, a government-subsidized freight railroad formed in 1974.

East of the Mississippi River, CSX and Norfolk Southern compete. In the West the two rivals are Omaha, Nebraskabased Union Pacific Railroad and BNSF Railway Co., headquartered in Fort Worth and wholly owned by Berkshire Hathaway. CP and Montreal-based Canadian National span Canada and own some rail assets below the 49th parallel.

Kansas City Southern Railway Co. is the only railroad that abuts six others; its routes run down the center of the U.S. and into southern Mexico. All tracks lead to Chicago, the city of big shoulders and, when bad weather or energy snafus intervene, epic train tie-ups.

In a sign of the times, train operators lack space in their rail yards to store all of the assets that have fallen into disuse. Miles of mothballed rolling stock and idle locomotives reveal an industry under stress. Iowa Pacific Holdings has invited controversy by parking hundreds of empty crude oil tankers on its rail siding in Adirondack Park, a nature preserve in upstate New York. The Chicago-based company has several other such storage sites, in locations as far-flung as Walsenberg, Colorado; Elk Grove Village, Illinois; and Watsonville, California.

Meanwhile, decisions to buy, hold or sell shares in freight railroads have reached a junction. They got a little overvalued. At some point, people expected that to continue into the sunset, says Andrew Davis, a transportation analyst with Baltimore-based asset manager T. Rowe Price. This is kind of an inflection point where investors are trying to figure out what to do with them.

This uncertainty hasnt scared off Pershing Squares Ackman and two other billionaires. Never mind a disappointing year for BNSF, the 1995 marriage of Burlington Northern with the Atchison, Topeka and Santa Fe Railway and the biggest position in the Berkshire Hathaway portfolio. Revenue at the fifth-largest Class 1 railroad fell 5 percent in 2015, to $21.97 billion.

In his latest annual letter to shareholders, Berkshire Hathaway chairman and CEO Buffett singled out the Omaha-based parent companys most important development last year: almost $6 billion in BNSF capital expenditures. That sum was far and away the record for any American railroad and nearly three times our annual depreciation charge, he wrote. It was money well spent.

In 2009, asked about his motivation for ponying up $26 billion to buy the remaining 77.4 percent of BNSF parent Burlington Northern Santa Fe Corp., Buffett didnt hesitate. Its an all-in wager on the economic future of the United States, he said. I love those bets.

Cascade Investment, the family investment office of Microsoft co-founder Bill Gates, counts CN among its five largest stakes. Since Gates disclosed the investment in mid-2000, CN stock has risen 13-fold, closing at C$81.18 on April 15.

Freight revenue is captive to downturns that sap demand for raw materials. Lacking any power over economic growth, rail managers focus on a dial they can adjust: operating ratio. A 70 percent operating ratio means that a railroad spends 70 cents of every revenue dollar and keeps 30 cents; other industries would usually frame that as an operating margin of 30 percent. Operating efficiency creates capacity, says CPs Creel.

CN has led the operating efficiency sweepstakes since onetime chief executive Harrison launched major cuts last decade. During the fourth quarter of 2015, the companys operating ratio edged below 60 percent, the railroad equivalent of beating a four-minute mile. Right behind, CP chopped 470 basis points from its ratio for the previous year, hitting 61 percent for 2015, its best-ever full-year result. For 2016, it projects a ratio below 59 percent. CSX ended 2015 boasting an operating ratio below 70 percent for the first time, even allowing for an uptick in intermodal volume with narrower margins.

Compare these ratios to the 87.5 percent in 2004 at Union Pacific, North Americas biggest Class 1 railroad. Last year its operating ratio was a much trimmer 63.1 percent, and management plans to reach 60 percent by 2019. A stretch goal with no stated deadline, 55 percent is a mindset as much as a financial metric to rally the organization forward, CFO Robert Knight said at a Stifel, Nicolaus & Co. transportation conference in February.

A fourfold CSX strategy to achieve an operating ratio in the mid-60s hinges on adapting the companys rail network to the new business environment, CFO Lonegro explains. The other three legs: leveraging technology to maximize efficiencies, boosting investment in intermodal and providing excellent service.

Now that CP has backed off from the proposed merger, Norfolk Southern can roll out a strategy aimed at streamlining operations. It faces a longer climb than other railroads, with a 2015 operating ratio of 72.6 percent and headed the wrong way, up 374 basis points from 2014.

Chief executive James Squires took over a year ago with the bar set low. Norfolk Southern saw net income drop 22 percent last year, to $1.6 billion; at $5.10, earnings per share fell 20 percent. Squires, who was already president and now also serves as chairman, has promised an array of cost reductions and improved operational efficiencies that seek to lower the companys operating ratio to 65 percent by 2020.

For two men who see eye to eye when it comes to railways, Bill Ackman and Hunter Harrison couldnt be more different.

While studying business at what is now the University of Memphis in his Tennessee hometown in the early 1960s, Harrison began his railroad career as a laborer for the now defunct St. LouisSan Francisco Railway. He worked his way up, rising to vice president of transportation and vice president of service design at Burlington Northern, which acquired Frisco in 1980. Harrison, 71, has never been shy about wielding the ax. Lobbying to switch to single tracks led to differences with a more cautious Burlington Northern CEO, hastening Harrisons departure in 1988.

He moved on to Illinois Central, becoming president and CEO before Canadian National bought the company in 1998. Starting out as COO of the combined business, he went on to serve as president and CEO until his retirement in 2009. At CN, Harrison earned a reputation for pushing the limits to boost profits. His signature moves: what he calls precision railroading  longer, faster trains that aim to deliver better service for less  and ripping out double tracks to lower maintenance costs.

Rather than maintain parallel tracks, CP relies on single ones and sidings long enough to accommodate trains nearly two miles long. You dont need 100 miles of double track, says president and COO Creel, a Gulf War veteran who left the military to work for Burlington Northern, where Harrison noticed and promoted him. Think about all the infrastructure you can remove. Over the past three years, CP has done 65 siding conversions.

With a handpicked team that included Creel, Harrison battled costs into submission at CN. In 2002, calling him a giant of railroading, trade publication Railway Age named him Railroader of the Year, an honor he would win again in 2015.

That zeal for efficiency wasnt lost on Ackman, who had bought 14 percent of CP in 2011 through Pershing Square, the $11.6 billion New Yorkbased hedge fund firm he runs. He called Harrison and lured him out of retirement. After a fierce proxy battle that displaced CPs previous management and saw Ackman take a board seat, Harrison signed on as president and CEO in June 2012.

The son of a real estate financier, Ackman, 49, has leveraged advantages bestowed by birth. He spent his college years at Harvard University, where he earned an MBA, and launched Pershing Square in 2004 after winding down an earlier investment business.

As an activist, hes had mixed results. Ackmans Pershing Square Holdings, a $3.9 billion closed-end fund listed in Amsterdam, lost 20.5 percent in 2015 and was down by the same amount this year as of mid-April. That dramatic fall owed much to havoc at another Canadian business, top Pershing Square holding Valeant Pharmaceuticals International, which announced in March that CEO J. Michael Pearson would be leaving amid a probe by the U.S. Securities and Exchange Commission connected to its pricing practices. Ackman has since joined the board of the Laval, Quebecbased company.

For a while CP followed a predictable script under Harrison: Successive quarters delivered record revenue and earnings per share, along with a shrinking operating ratio. In October 2014 the companys share price peaked at C$241.67, more than triple its value when Harrison took charge. But aside from a few rallies, the stock  Pershing Squares stake stood at 9.1 percent in March  has been in decline ever since.

All of this may have put pressure on CP to pursue a union with Norfolk Southern. Given his recent losses, Ackman arguably had more riding on the deal than Harrison, who has claimed that a merger with CSX would suit him equally fine. Look, if nothing happens, weve got a wonderful franchise here in Canada, he said of the Norfolk Southern bid on a January earnings call. We have not fallen in love with any deal.

Through the 200809 financial crisis and other rough patches during the past decade and a half, railroads have proven resilient. Cash flow easily financed operations, capital expenditures, debt service, dividends and buybacks (see table, page 33). Now, with U.S. unemployment falling, home prices approaching precrisis levels in some areas and a service economy fueling demand for intermodal transport, trains appear poised for another growth spurt. Railroads assert that the intermodal business will pick up the slack left by the commodities crash.

At CN, intermodal furnishes the building blocks of all the initiatives that we have put together over the last five years, president and CEO Claude Mongeau recently told analysts. The vision: freight cars filled with television sets, furniture and appliances getting to retailers and consumers in timely fashion. New rolling stock will cater to this rising demand, and updated rail yards will move intermodal goods with peak efficiency.

CSX, which reported moving 2.8 million intermodal loads in 2015, sees plenty of room for growth. In the eastern U.S., trucks now carry 9 million freight loads more than 550 miles, a distance that makes those shipments good candidates for conversion to intermodal. A modest share of this additional business would multiply volume and spread fixed costs across a wider base, lifting profits. CSXs intermodal activity has doubled in the past ten years; it started from a low base, but thats five times the expansion in truck freight, CFO Lonegro says.

Structural barriers could hamper intermodal progress. The average train speed of below 25 miles an hour, subject to innumerable crossings and local speed limits, poses a challenge to swift long-distance rail delivery. At such a crawl, trains can take two days to cover 1,000 miles, a distance that trucks travel in half the time and planes in much less for high-value cargo.

In some North American rail corridors, however, intermodal trains have gained traction, validating hopes for robust growth. Big changes wont happen overnight. Managers who normally focus on the next quarter take a long view of intermodal, with Lonegro forecasting a secular shift that will happen over time.

Norfolk Southern chief marketing officer Alan Shaw is equally cautious. Our customers are committed in the intermodal network to long-term growth, and they understand that we need to be able to invest in the network to accommodate the growth, he said in January. And so were taking a long-term view of this.

As railroads vie for intermodal, the trucking industry faces its own struggles. Lower oil prices have helped trucks, which use roughly six times as much fuel as trains to carry a load the same distance. But the wear and tear from poorly kept highways has jacked up maintenance and replacement costs, and ubiquitous congestion slows trucks down. Worse still, driver turnover exceeds 75 percent a year.

I heard that one trucking company actually has more employees attempting to recruit drivers than obtain sales, says veteran rail consultant Charles Banks, president of R.L. Banks & Associates, an Arlington, Virginiabased firm that has advised global freight railroads since 1956. If that doesnt paint a picture then I dont know what does.

Its too soon to predict an intermodal outcome. Large long-haul trucking companies can still fight for business even if it means trimmer profits, and coexistence is crucial, given that freight depends on trucks for short hauls between loading docks.

Capital expenditures divert 15 to 20 percent of railroad topline revenue, largely to maintain current assets. Its a big chunk, but as a result, rail companies invested in track beds and modern facilities as taxpayer-supported highways deteriorated. With the exception of CN, capex may take a breather in 2016 to ease expected pressure on cash flow, a rich source of capital for dividends and stock buybacks.

If CPs Harrison has his way, regulatory hurdles wont stop the Class 1 railroad club from dwindling to six members or fewer. M&A is going to happen, and it should happen, he declared at the start of the year, when he had more cause for optimism. Its just a matter of time. 