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Warren Buffett’s 2009 rail purchase showed the sector was undervalued.
When American thinks of transportation, they are most likely to think of cars, trucks, and planes. Put the same question to investors, however, and many will think of trains. America has a vast rail system, and it’s easy to forget that plenty of massive loads can only be transported by rail.
Warren Buffett might have said it best when Berkshire Hathaway (NYSE:BRK) purchased Burlington Northern in 2009, calling railroads the best-positioned raw material and finished goods haulers.
There is infrastructure all over our great nation, railroads that have exited for generations. Yes, it needs to be updated. However, the good news is there isn’t much updating that needs to be done and oftentimes, the government will pick up the tab. That leaves capex to just maintaining a company’s own materials.
Railroads are also a “business of necessity”. It’s one thing to transport a few sheep from point A to point B. It’s another to have to move hundreds of tons of material across the country. You can’t use a plane. You can’t use a car. You could use a fleet of 18-wheelers. The most likely scenario is to move by rail, and that puts you at the mercy of the companies in the space. They therefore have pricing power.
That lack of massive capex is probably what keeps the railroads from being less profitable than they are. CSX Corporation (NYSE:CSX) has doubled EPS, quintupled dividends, and repurchased $8 billion of shares since 2006, while driving the stock to a 150% return. Driven by a recovering housing market, good harvests in the farmland, and the constant need to transport energy, CSX is poised for good years ahead.
The company carries $8.4 billion in debt, but cash from operations was $3.26 billion (last year. It’s a very profitable business model, with operating margins of 28% and net margins of 14.7%. You might not expect that from such a capital-intensive company, but again, it’s only their railcars they have to attend to.
Kansas City Southern (NYSE:KSU) is another railroad enjoying good times. Earnings per share are actually scheduled to rise at a faster rate than CSX, 15% long term vs. 10% for CSX.
Again, we see great profitability metrics, with operating margins of 32% and net margins of 18%. Meanwhile, Norfolk Southern (NYSE:NSC) also expects 11% long term earnings growth.
This is all really great news for railroads. Looking at the long term EPS trends, CSX trades at 17 times earnings vs 10% long term EPS, so that’s a bit overvalued. Norfolk trades at 17x vs 11% long term EPS growth, and Kansas City trades at 25 times estimates on 15% growth. They also all pay dividends.
Are they therefore all overpriced? KSU stock has the best balance sheet with only $1.1 billion in debt, but free cash flow tends to hover around the break-even line. NSC has a lot more debt, but more robust cash flow.
So while they aren’t the values they once were, the long term trends favor all of them. I’d probably go with the fastest grower, and that is KSU.
Lawrence Meyers holds no stocks mentioned in this article.
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