Railroad Companies – A Solid and Steady Investment
The railroad industry is divided into three distinct groups or ‘Classes’ in accordance with the Surface Transportation Board, an administrative affiliate of the Department of Transportation. They are as follows:
- Class I – Large North American railroads with revenues of more than $450 Million per year and generally have activities across US borders;
- Class II – Regional railroads with revenues between $36 Million and $450 Million per year and tracks of at least 350 miles;
- Class III – Local railroads including ‘Short Lines’, most Class III railroads are local government owned agencies providing rail service to their citizens.
In general, Class III railroads are not publicly traded investments, they are privately held operations. Class II railroads mostly exist as private investments for equity groups or are part of a holding company. One of the largest holding companies for railroads is Genesee & Wyoming Inc. which owns over 100 regional and local railroads. Genesee is currently transitioning from a public corporation to a privately held investment. There are currently about a dozen publicly traded Class II railroad companies. Most of them are targets by holding companies as good investments for long term cash flow.
Lastly, are the big operations. There are seven Class I railroads of which six are publicly traded. The seventh, BNSF, is solely owned by Berkshire Hathaway. The publicly traded Class I railroads are:
- Union Pacific
- CSX
- Canadian National
- Norfolk Southern
- Kansas City Southern (Merged with Canadian Pacific in late 2021)
- Canadian Pacific
These six are behemoths when it comes to transportation. All have revenues greater than $2.5 Billion per year and hold at least $4 Billion in fixed assets. The key to this investment is the asset allocation model. A common thread that binds all of them is that the asset side of the balance sheet is fixed assets intensive. Basically, more than 85% of the assets are fixed in nature. The balance is comprised of receivables, cash and some long-term amortizable rights.
Due to this asset structure, there are some business principles every investor should understand because they are applicable to railroad investments. First and foremost is the fixed asset maintenance/upgrade relationship with depreciation expense (allocation of utility value). The next principle is referred to as the break-even point. In general, long life fixed asset driven entities have lower financial break-even points than a traditional company. A third and probably the most influential element of profit for a railroad company is the concept of marginal dollars adding a very high percentage of each marginal dollar of revenue to the profit. The following three sections explain these three principles in more detail related to how they are applied to railroad financials. The final section ties it altogether for the investor as to why railroad investments are a solid and steady investment. Future articles related to this series utilize these three principles when discussing/explaining the respective investment.
Property, Investment and Depreciation
In business, fixed assets generally have a low cost to maintain or have costs that can be deferred during lean times. A good example are real estate investments, they too are fixed asset intensive. If the economy slows, hotels, apartment complexes etc. can delay upgrades or replacements of fixed assets. The same is true for railroad companies. If an investor reviews the cash flows statement of a railroad operation you will discover value associated with upgrades and long term maintenance changes in the investment section. With railroad companies, the most common investment ratio is at least two and half times the depreciation charged during the recent year.