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Warren Buffett‘s Berkshire Hathaway (NYSE: BRK-B) bought Burlington Northern Santa Fe for $26.5 billion back in 2010. It was his biggest acquisition ever.
Since then, Buffett’s railroad stock investment is paying off nicely. Some estimates suggest that the value of Burlington Northern has doubled, thanks to soaring profits and cash flow.
The growth at Burlington Northern has been helped by the boom in oil production. The oil pipelines haven’t been able to keep pace with the capacity coming out of the major shale plays, like the Bakken Shale. They’ve turned to Burlington Northern and other railroads.
However, with oil hovering around $50 a barrel, there’s some worry that the major oil transporters could be in for a rough ride. Even with the concerns over declining oil production, which means lower oil to be transported, certain railroad stocks are still very enticing investments.
That’s because these guys not only have vast networks, but also impressive pricing power. This allows many of them to enjoy double-digit profit margins.
Much of the economy is driven by consumer spending. So more money in their pockets, thanks to lower energy costs, should help increase demand for major products that rail companies move, which include autos, electronics and lumber.
Buffett has said before, “As long as more goods move from place to place in this country, rails are going to get their share and it should be a very profitable business.”
If you own shares of Berkshire Hathaway, than you already have some exposure to the railroad sector. If you want to own railroad stocks, here are two to consider. Warren Buffett already has his railroad stock, and you should too.
No. 1 Railroad Stock to Buy: Union Pacific (NYSE: UNP)
Union Pacific (NYSE: UNP) is a lot like Warren Buffett’s Burlington Northern. They are the only two major plays in the West and both have seen a nice boost from the oil shale boom. Back in August, I called Union Pacific the best-kept secret in the West.
With its 32,000 miles of rail, Union Pacific is not only a key player in moving oil, but also has a strong presence in moving lumber, autos, food, industrial products and more. The stronger demand for other products should help offset any declines Union Pacific sees from shale oil exports.
No. 2 Railroad Stock to Buy: Canadian National Railway (NYSE: CNI)
Canadian National (NYSE: CNI) is a major player when it comes to inter-country rail shipments between the U.S. and Canada, with over 20,000 miles of track. It actually has the largest rail network in Canada.
While it does have exposure to the oil industry, its largest segment is intermodal, which moves manufactured and consumer products. There are a number of reasons that Union Pacific and Canadian National Railway are the top two plays in the rail space.
Why are these the top two railroad stocks to buy today?
Both stocks have double digit-profit margins that are tops in the industry. Union Pacific’s profit margin is near 22% and Canadian National Railway’s is at 26% over the last 12 months.
As well, their returns on assets, returns on equity and returns on invested capital are all superior to the other rail companies. For example, Union Pacific has a return on invested capital of 17.1% and Canadian National Railway’s is 15.7%; meanwhile, CSX (NYSE: CSX) has an ROIC that comes in at 11.9%, Norfolk Southern (NYSE: NSC) at 11.4% and Canadian Pacific (NYSE: CP) at 9.8%
With long-term debt-to-equity ratios of less than 60%, the Union Pacific and Canadian National Railway balance sheets are, again, some of the best in the business.
Then there are the dividends. Union Pacific pays a $2.20 per share annual dividend that yields 1.8%. That translates into a payout ratio of 33%. While the yield doesn’t seem like much, Union Pacific has paid a dividend for 34 years. It’s also more than tripled its dividend over the last five years.
Meanwhile, Canadian National Railway pays out a $1.25 annual dividend. Its dividend yield is 1.4% and that’s just a 36% payout ratio. The company has been paying a dividend for 17 years.
Consider this: On a total return basis for the last five years, UNP is up 320% and CNI has gained 195%. That compares quite favorably to the S&P 500, which is up 114%.
The bottom line is that railroads are solid businesses with wide-moats. Their railroads networks are virtually impossible to replicate. When it comes to moving goods, rail is also the low-cost shipping option compared to ships, trucks and aircraft.
Union Pacific and Canadian National Railway are two of the most interesting plays in this space. If Warren Buffett didn’t already own Burlington Northern, I bet he’d be taking a close look at these two railroad stocks.
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