Wednesday, September 9, 2015

Sector Overview – Railroads

Fewer investments garner as much as attention to the pulse of the economy as the railroad sector. The railroads are considered a leading indicator for the overall health of the economy as transportation of goods is critical and gives investors a sense of how companies and consumers are spending their money. If we observe legendary investors such as Warren Buffett and Bill Gates – it is clear that they are fans of the railroad companies and believe in the long term prospects with Buffett’s Berkshire Hathaway buying out Burlington Santa Fe (BNSF), taking it private and Gates’ Cascade Investments holding a sizeable position in Canadian National Railway. Railroads are what we call a wide-moat industry sector – where it is extremely hard for new entrants to get established and challenge the incumbents. This makes the railroads very attractive for long term investors.


Whether transporting crude, lumber, merchandise, agricultural or industrial products, railroads are what keeps the economy moving. While the transportation for entities such as coal (which used to be the largest users of railroad services a few years ago) has fallen due to the fall in crude prices and rise of green energy alternatives, the transportation need for crude saw significant rise in the recent past. However, the recent turn of events with falling energy prices, has put a damper on crude transportation via railroads. The following chart from Association of American Railroads shows the trend in traffic for various payloads.

Sector Overview – Railroads

The North American railroad industry is made up of just six companies: Union Pacific Corp, Canadian National Railway Company, CSX Corp, Norfolk Southern Corp, Canadian Pacific Railway Ltd, and Kansas City Southern. All numbers used below are in US$.
Company Ticker Market Cap Rail Network Yield
Union Pacific Corp UNP $80.57B 31,000 miles 2.37%
Canadian National CNR.TO / CNI $49.05B 20,000 miles 1.57%
CSX Corp CSX $29.18B 21,000 miles 2.43%
Canadian Pacific CP $25.47B 13,700 miles 0.68%
Norfolk Southern NSC $24.73B 20,000 miles 2.88%
Kansas City Southern KSU $10.88B 6,500 miles 1.34% 
The following charts provide an overview comparing the railroads
Railroads - Mkt Cap
Railroads - Yield

Union Pacific Corp

UNP map
Union Pacific Corp (UNP) is the largest railroad company in North America. The company operates west of the Mississippi river and has a rail network operation of approx 31,000 miles. The company is one of the best run in the industry and has a great operating margin at 37%.

UNP is a Dividend Challenger having raised dividends for 9 consecutive years. The dividend growth rates for 1-, 3-, 5- and 10-yr periods are 22.0%, 23.2%, 27.3%, and 19.7%, respectively. With an initial yield of 2.37%, UNP’s Chowder Rule number of 29.67. Current payout ratio stands at a manageable 36%.

The biggest risk UNP faces is that the rail map directly overlaps that of Burlington Santa Fe, a company that is a subsidiary of Berkshire Hathaway – which is investing heavily after taking the company private to upgrade their network and operate more efficiently.

Canadian National Railway Company

CNI map
The Canadian National Railway Company (CNR.TO, CNI) is the second largest railroad company in North America. It is the only company operating rail networks serving three coasts – Pacific, Atlantic and Gulf coasts; a network of approx 20,000 miles. CN has the best operating margin in the industry at 39.6%.

CNI is a Dividend Champion having raised dividends for 18 consecutive years. The dividend growth rates for 1-, 3-, 5- and 10-yr periods are 9%, 11.3%, 15.2%, and 17.4%, respectively. With an initial yield of 1.57%, CNI’s Chowder Rule number of 16.77. Current payout ratio stands at a manageable 27.9%.

CSX Corp

CSX map
CSX Corp (CSX) is the third largest railroad company in North America – with rail network east of the Mississippi river serving 2/3 of the US population with a network of approx 21,000 miles. CSX’s operating margin is 29.9%.

CSX is a Dividend Champion having raised dividends for 11 consecutive years. The dividend growth rates for 1-, 3-, 5- and 10-yr periods are 6.8%, 12.1%, 16.5%, and 25.2%, respectively. With an initial yield of 2.43%, CSX’s Chowder Rule number of 18.93. Current payout ratio stands at a manageable 32.8%.

Canadian Pacific Railway Ltd

CP map
Canadian Pacific is the smaller of the two Canadian railroads operating mostly in Canada but with some extensions into the US market. The company operates approx 13,700 miles of railroad and has an operating margin of 38.3%.
CP has lost its dividend growth streak after failing to raise dividends since 2013. However, the current payout ratio stands at a manageable 15.2%. CP approached CSX earlier this year proposing a merger to create the second largest rail network in North America, but the deal did not gather traction as CSX rejected right away.

Norfolk Southern Corp

NSC map
Norfolk Southern Corp (NSC) operates a rail network east of the Mississippi river directly competing with CSX Corp. The company operates approx 20,000 miles of rail network and has an operating margin is 29.6%.

NSC is a Dividend Champion having raised dividends for 14 consecutive years. The dividend growth rates for 1-, 3-, 5- and 10-yr periods are 8.8%, 10.2%, 10.3%, and 20%, respectively. With an initial yield of 2.88% – the highest in the industry, NSC’s Chowder Rule number of 13.18. Current payout ratio stands at a manageable 39.5%.

Kansas City Southern

KSU map
Kansas City Southern (KSU) is the smallest of the railroads – serving the Southern US and Mexican markets. The company operates a rail network of approx 6,500 miles and has an operating margin is 32.6%.
KSU started paying dividends in 2012 and has a relatively short dividend payment history. Current payout ratio stands at a manageable 25.6%.

Summary

Railroads provide a great long term investment opportunity as they provide a wide moat and are a critical part of the economy. A small space with just six major players in the North American space, the railroad sector has great operating margins and provide consistent dividends and dividend growth for income-focused investors. The following table provides a summary  of the metrics as of this date of writing.


Do you own stocks in this sector? Which ones do you own and what are your thoughts on the future of the industry and companies mentioned. Share your thoughts below.

Full Disclosure: Long CNR.TO. My full list of holdings is available here.


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