and Bill Ackman have helped make investors seriousmoney in
the railroad industry over the past couple of years. If you
missed these opportunities while trying to navigate the financial
crisis, never fear: There's still time to get in on the next
great railroadinvestment .
Back in 2010, Buffett tookmarket leader BNSF private at a
roughly 30% premium. Ackman went into activist mode at Canadian
Pacific Railway in 2011 after Canada's No. 2 rail company had
grossly underperformed top peer Canadian National for a number of
years. For the three years prior to Ackman's Canadian Pacific
stake, thestock was down 5%, while Canadian National was up
Since Ackman got involved during mid-2011, Canadian Pacific
has outperformed Canadian National four times. There's definitely
still money to be made in railways.
A similar opportunity is forming at
Norfolk Southern (
. The company has been essentially flat over the past five years
and is in dire need of some activist-style
Norfolk's stock is up a mere 3% over the past five years.
Compare this with top rival CSX, up 20%;
Union Pacific (
Kansas City Southern (
, each up 100%; and
Canadian National Railway (
, up 85%. Even the S&P 500index has grossly outperformed
Norfolk, returning 25%.
Ackman's key thesis at Canadian Pacific was that
managementissues were to blame for the company's
underperformance. He was instrumental in oustingCEO Fred Green
and getting former Canadian National CEO Hunter Harrison
appointed to the topseat .
A big positive for Norfolk of late has been its own management
shakeup. In June, James Squires took over as president,
essentially separating the CEO and president roles. Current CEO
Charles Moormanwill now focus solely on operations, while Squires
will take over managing strategy and planning. Well-managed
railroads are afforded higher valuations, and this is a first
step toward a higher valuation for Norfolk.
One hot-button topic is pollution, which Norfolk is looking to
tackle. Earlier thisyear , Norfolk laid out its initiatives,
which includes fuel efficient engines, and turning to battery-
and biofuel-powered engines. Its long-term goal includes lowering
its greenhouse emissions by 10% per mile before 2014.
While the more efficient engines will no doubt help with
emissions, there are company-specific benefits that are not to be
ignored. As these engines come into play, the company should
start seeing material improvement in loweroperating expenses
What makes Norfolk interesting is that with some slight
improvements in the company, shareholders could easily be
rewarded with shareappreciation , and not just the
industry-leading 2.7%dividend yield it pays.
Last quarter, Norfolk'soperating ratio (operating expenses
divided bynet revenue ) came in at 70.2%, compared with CSX's
68.6%. That might not seem like much, but it can be the
difference of several million dollars over the course of a year.
Norfolk and CSX have similar balance sheets, but CSX has a return
onequity of 20%, while Norfolk is at 17%. Norfolk's move toward
more efficient engines and operations is a first step for
lowering its operating ratio and boosting returns on equity.
One of Norfolk's biggest initiatives for boosting itstop line
is to promote the move from trucks to trains, hence the gaining
strength of its intermodal segment. The coming online of its
Crescent Corridor, an intermodal corridor connecting Louisiana
and New Jersey, should only further help drive the trading in of
trucks for trains. Helping exacerbate the growth in intermodal
should be the double-stacking that Norfolk is implementing. The
majority of its intermodal shipments are now double-stacked,
which allows Norfolk to move more cargo with fewer trips, leading
to higherrevenue per mile.
As natural gas prices tanked over the past few years, the
trading in of coal for natural gas by the major power companies
squeezed a number of major railroad operators, where coal
transports have historically been a major part ofrevenues .
Norfolk is mitigating this transition nicely, as revenues from
intermodal should come close to passing coal this year as its top
revenue generator. Intermodal volumes were up 8% in the past
quarter, compared with coal being down 4%.
One of the real beauties of Norfolk is that thedownside here
is limited. The North American railroad system has one of the
best-known legal economic moats in the world, as the railroad
industry has infrastructure that just cannot be replicated. The
amount of money that it would take to replicate such a network is
unimaginable, not to mention the inability to access the land,
where railroads hold age-old rights of way.
Risks to Consider:
Norfolk could fail to maintain its managerial and operational
improvements and revert to being a subpar railroad operator.
Railroads are also inherently tied to theeconomy , so any
unexpected pullback in the recovery could be a big negative.
Action to take -->
Investors can buy Norfolk now for roughly 70 cents per dollar of
assets, which is well below any of the other major railroads.
With the inherent moat that the railroad industry provides,
there's not much room on the downside. With operational
improvements, Norfolk should trade in line with the leading U.S.
railroad operator, Union Pacific, at 17.5 timesearnings . That
price-to-earningsmultiple onanalysts ' 2014 earnings per share
estimates for Norfolk wouldyield a $110price target .
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