In a Million Dollar Nutshell 🌰 You Can Rely on Rail 🚅
Railroads make a sturdy long-term investment. They’re seen as great long-distance freight carriers and great low-risk anchors for investors. Find a railroad with good management, and check it serves a diverse range of customers who all have long-term prospects in their own right. If you’re interested in how to invest in railroad stocks that are less risky, pick a railroad that leases it’s railcars instead of buying them. Rotate into the industry as the economy veers off track. Why? Tried-and-true rail businesses repair their stock prices very early in a recovery. And all the better if oil prices are low, because the recovery of oil will move freight to rail from trucks. Don’t stress over the railroads battling each other, they hardly do, just focus on tracking the best management teams because they’re the custodians of your money.
Time to Bulk up on Rail Know-How!Disclaimer: I do not own any railroad investments at the time of writing. Disclaimer: chrismorrissey.money does not provide financial advice. All content is purely informational. Consult independent advice.
Vanderbilt pioneered them, but time made them the poster-child investment of patient money. In this investing industry primer you’re going to learn how to make money with stocks of the railroad industry. These businesses haul cargo up and down the United States. I’m going to reveal how the sector is structured, railroad competition, risk, the golden mix of freight, and how to measure the value of railroad stocks. The industry has existed for almost 200 years, so all the more important you be primed with how to invest in railroad stocks.
This sector of the business universe is huge. It’s one of the 11 GICS sectors, encompassing every business involved in making things and moving things. When it comes to railroads, we’re on the topic of moving things.
Transportation Industry GroupWhat are we investing in? It’snot passenger rail travel. That’s covered by Amtrak.It’s freight. It’s cargo. Why do railroads exist to carry freight? Look around you at the essentials in your life. In all of these things, parts are needed. Someone has to be responsible for the transportation of the parts, getting them from the factories into the shops, A-to-B. That’s where the transportation industry group comes in.
The customers are businesses, not individuals like you and I. Transport can be done by truck, ship, air, or rail, the choice depending on factors such as price and urgency. Reliability and time in transit are also important.
Train-Spotting The Best Stocks 👀
You can usually invest in these railroads. They’re the long haulers and the main actors of the industry, pulling railcars across the US.
In the 60s there were over 106 Class 1 railroads. They all suffered financial difficulties however and have since merged into just six. The main four of these six account for 90% of the freight moving across America!
- CSX in the East
- Burlington Northern and Santa Fe in the West (absorbed into Warren B’s Berkshire Hathaway)
- Norfolk Southern in the East
- Union Pacific in the West
All the players in this railroad world rely on each other to maintain a more and more efficient rail industry to invest in! This railroads primer will now focus almost exclusively only on the Big 4 railroads.
An Economy Proxy ⛳
Railcars are stacked high with the produce of America. That makes railroads a part of the fabric of America, their tracking spanning the country like veins, carrying the lifeblood of the country: raw materials, food, cars and chemicals. Railroads, therefore, are a very good proxy for how well the economy is doing. Stand back and watch asdemand for rail booms when consumers are spending, as greater tonnages of goods need hauling around the country. Watch it boom further as consumers demand those goods in a thriving economy. However, watch demand for rail contract as recessions take hold and the country undergoes a credit squeeze.
So, railroad profits are a largely a function of prosperity on the land their tracks are laid upon. Prosperity peaks and troughs, running in cycles, so railroads are very cyclical businesses. Here is Ray Dalio’s wonderful video on business cycles.
It’s Hard for Management to Screw-up 💼
Here’s the kicker, rivalries are at sector levels, not industry levels. This is because the railroad sector is full of options, not functions. Huh? Well, when something needs transporting, multiple modes of transport can get the job done. Rail, trucks, ships, and don’t have to work together. They don’t all have to perform a role, playing a unique part in a process to get a good from A-to-B. The customer has all four modes of transport, as options to choose from. The customer doesn’t rely each of the four to perform a function. Get it?
So, which mode of transport will the customer choose? Within an industry, competition between railroads is relatively peaceful. It’s not railroad X vs railroad Y, it’s rail vs ships, rail vs air, rail vs trucks. Now we know who’s competing, let’s reveal the competitive advantages railroads as a whole boast against these other modes. We won’t funnel our focus too singularly on individual railroads, yet!
Rails Competitive Position 🏅Road and rail lock hornsas the most popular mode choices for moving freight. They complement each other now with intermodal railcars, where you can put a truck trailer on the back of a railcar. It’s a neat invention, so the two rivalling modes are able to share business with trucks getting the ‘final mile’ done. This works as long as the customer doesn’t mind dealing with 2 different transport providers!
If they can’t share business together, who wins a 1v1 head-to-head? Trucks or railroads? By far the most important factor is distance.
Journeys longer than ∼500 miles shift freight from trucks to rail.
What else affects the choice? One the one hand, rail doesn’t transport very valuable cargo at-all compared to other modes. Look at your smartphone! Valuable things today are getting lighter and smaller, which is more suited to trucks. However, the more environmentally friendly option has to be rail, and since it’s also more fuel efficient…
As gas prices rise; freight shifts earlier from trucks to rail at ∼400 miles.
This is a real tug of war to keep an eye on. Ultimately, the cornerstone value proposition for rail is its speed, flexibility and reliability over a distance.
Railroad Stocks Like #CSX, #UP, and #NSC 🛤
A duopoly is a market with only two dominant firms. So we have a duopoly in the West of the US, and a duopoly in the East. In sparse regions, duopolies turn into monopolies (uno firma). The two railroads on each side of the US aren’t really competing. Both Union Pacific and Burlington are each twice as large as the East coast railroads but there’s little they can do to disrupt them because capital expenditures are so huge. That means the cost of maintaining a railroad business is very high. There’s an immense price to pay for expanding geographically into anothers space, so they don’t both and instead compete only on job contracts.Railroad stocks have long term prospects at the expense of growth prospects. Left to its own devices, a railroad will grow with the economy. The industry’s growth rate over the long-term is the same as the economy’s.
Railroads can can bolster their individual importance and potentially their regulatory clout if they have track laid in advantageous areas.
- Warren Buffett’s railroad, BNSF, has the most exclusive routes in states with the highest rail traffic tonnage:
- The railroad, UP, has exclusive gateway routes into Canada or Mexico.
- Any railroad with exclusive routes to natural resource hotspots like the Powder River Basin, frac sand deposits, and large grain producing regions, can also benefit.
Golden Freight Mix 🏆
We know where rail stands as a method of moving freight, but what freight? The inside of a railcar container is vital in analysing railroad stocks. You can consider the cargo; the customer.
UP carry construction materials, grain and chemicals. That means they rely on the construction industry, the agricultural market, and the chemical market.Get to know them. You need to understand whether these industries are they cyclical, seasonal, or why they chosen to go with rail as their primary mode of transport and what could upset that decision. Try and work out at what distance oil prices will force them into truck transport over rail.
As investors, our key word when investing in a railroad is diversification. We want our railroad earnings made from a diversified mix of customers and markets, each with long-term prospects.
Make sure your railroad stock has all the different types of boxcars it needs to serve a diversified market. Whether they be bought or leased, they need to be there and in good nick.
Now, look at the size of the margins on freight that the railroad is carrying. If Union Pacific wins a contract to carry a freight mix that is more profitable than Burlington’s, that’s better for its stock in the long run. I’m led to believe chemicals are the most profitablecargo, followed by coal. Intermodal freight is also nice to see in the mix.
Coal has to be transported by rail but its role in electricity generation is fading given that we’re getting off fossil fuels. It pays to do your homework on the markets that railroads serve if you’d like to actively invest in them.
Smaller Railroads Are Less Risky 👶
The main railroad index is DJUSRR. It puts all the railroads in a basket for you to invest in and track. Railroads are not a speculative industry in the slightest.
Railroads have 4 main costs:
- Depreciation of equipment
Fuel weighs heavy when it comes to risk. It’s the most variable of a railroads costs but the smaller a railroad is, the more likely it will rent its railcars than actually buy them. That’s important because the regional railroad gets to pass on its fuel costs to the leasing company in that process, moving along all the risk in volatile fuel prices. That’s pretty neat, but remember, smaller railroads may not be able to compete for as profitable freight mixes or have awesome routes compared to the big four railroads.
Check if the railroad you’re analysing imposes a fuel surcharge to stamp out risk in volatile Brent Crude. If it don’t, going for a smaller railroad will be more risk averse.
So Much Debt, But it’s Okay 💰
Railroads take on an awful lot of debt, but they do so because their revenues are so stable. All the railroads are investment grade but it’s still good practice to check the interest coverage and debt to equity ratios of each. You can find out what those ratios mean by watching the investing course on this website.
To Speed up Profits, Speed up Railcars ⏩
Notwithstanding the methods of scrutiny your come up with yourself, here’s how to break down the performance of your railroad and its management. We will start by measuring efficiency:
Measuring Railroad Stocks by Profitability
Our first port of call is to check the long term trend of revenue per ton mile. This is what we earn for every mile we move a ton of freight. The Big four railroads average about 3-4 cents per mile.
Valuing a Railroad 🚉
It’s important to value the stock and understand what it will return to you at any given price. Decide what hurdle rate of return you will accept before doing the valuation, and use these metrics only in support of a conventional DCF and proper fundamental analysis. Excel templates for DCF models this simple can be found with a Google search, but only hard work will get us in front of the variables that come to matter with these stocks. Most investors can’t stomach that, which leaves the door open for us to win!
Instead of agonising over the short or medium term future of rail, most investors willwait for a recession. This is because the industry is so cyclical and intertwined with the economy, so waiting for the economy to falter and railroad to fall, creates an opportunity to capture low prices. A railroad index like DJUSRR keeps things simple at a time like this, but it still takes bravely, buying on the way down because you know this industry will rebound in the most early stages of an economic recovery. You won’t be able to time the bottom, and that’s why investors will begin to rotate in for the recovery in staggered buys on the way down. Having the guts to buy earlier on the way down is what most investors don’t have, and that’s why the reward exists on the other side of this tactic.