April 22, 2008
Railways have been one of Buffetts larger common stock investments. Certainly Buffett came pretty late to the party, but, is there more to come?
The Railway industry, once the premiere investment amongst listed securities. Today almost forgotten by the media. The history of the industry as listed securities extends for over one hundred years. During this time there have been tumultuous changes in the industry. Numerous bankruptcies, reorganizations and business vicissitudes have been hallmarks of the railway industry.
By way of concrete example, Penn Central, was the result of a merger between the “Pennsylvania Railroad” and the “New York Central Railroad” in 1966. Penn Central, by 1970 was itself bankrupt, and eventually reorganized into “Conrail” a government holding company, that was itself bought out by CSX Corp. and the Norfolk & Southern, one of the carriers under analysis.
Yet, through all these travails, the industry has remained vitally important to the American economy and industry. The industry in point of fact was so vital throughout America’s history, that regulation from Federal agencies has been a component of the industry, and remains partly in effect to this day, although, the regulation has started to give way in some instances to free market competition.
The Transport industry, of which the Railways form an important component, while possibly no longer possessing the glamour and excitement of the “GOOG’s” of the investment community, nevertheless provide an essential service to industrial and agricultural America, the same as provided by the “arterial” system to the heart. Yet, the investment community seems to have forgotten about the rail industry.
As investors, what if anything does the Rail industry offer us currently? This question is the one that we shall address. Historically the industry has always required large and regular infusions of new capital. It has been this requirement that has on many occasions led to the over-bonding of individual carriers. It is precisely this tendency within the industry that provides accurate warnings of impending problems with the individual carriers. Thus, the investment quality of both the Bonds and Common can be assessed via an examination of the statistical exhibit regarding interest payments and operating ratios.
The analysis of an individual company is usually carried on against a background of the industry to which it belongs. The future of the individual company usually being assumed to be inextricably linked with the industry. This has not always proven to be true however. The individual carriers have had an ignominious history of bankruptcy, reorganization and consolidation, much of it at the hands of the Federal government. This underlies the over-all importance of the industry, yet the consistent weakness of the individual carriers. It is interesting to note that in Europe, the rail industry has had a long history of “public” ownership via the governments public funding and support.
The overall number of Class 1 railways as defined by the Surface Transport Board (earnings in excess of $250 million) has decreased the number from many, to just a few over the past 100 years. Many of the previous great names are now just memories of stock market and operating history, yet they still exist for the most part in the three major companies.
Taking a short walk down stock market history, we find that the total number of Class 1 Railways has dropped precipitously to the following names; BNSF (Burlington) Canadian National Grand Trunk Western RR, CSX Transportation Inc. Kansas City Southern RR, Norfolk Southern Combined, Soo Line RR and the Union Pacific. Compared to the list existing in the 1930’s………Atlantic Coast Line, Baltimore & Ohio, Canadian Pacific, Chesapeake & Ohio, Chicago & North, Chicago & Great Western, Chicago, Milwaukee, St Paul & Pacific, Chicago, Rock Island & Pacific, Great Northern, Illinois Central, New York Central, New York Chicago & St Louis, Norfolk & Western, Pennsylvania RR, Pere Marquette, Reading Co. St Louis, San Francisco, Union Pacific, and the Wabash and even this list is far from complete.
The long history of the railways, their trials and tribulations form a record that should teach today’s investors the lessons of the past. This lesson being, that no matter how important the over-all industry, to the economic prosperity of the nation, individual carriers have, through a variety of reasons become historical fact, and distant memories. Today’s investors would be prudent to heed the warnings of the past.
The analysis of the company, in its form, will in part be governed by the operating characteristics of the industry. Attention can be given to a myriad of factors, geographical location of markets and plant, to the character of competition, both internal, from other carriers, and external from, air, road and sea, to labor costs, government regulation, or deregulation, and special taxes. All of these components are important, and yet are reflected within the operating results over a period of time.
The Railway industry provides an embarrassment of wealth in regards to statistical information. This allows an analyst reliable quantitative data with which to analyze the business and its operations. There are three ratios which traditionally have been given the most importance or weighting. They are (1) the operating ratio, (2) the coverage of fixed and contingent charges, (3) earnings per share of common and preferred.
In a more detailed analysis, further study is undertaken within the financial and physical areas. Within the financial, further ratios are calculated for the maintenance of way, and equipment, and transport ratios. Within the physical, are calculated “net ton miles per train hour.” These ratios are calculated to examine the causal or correlative factors that result in poor or superior operational ratios. They identify the reasons for the either poor or superior statistical exhibit, via a measurement of costs against revenue, but do not alter the conclusion inferred by the analysis provided by the three traditional ratios.
The purpose of any research or analysis should have a “raison d’etre”. This will be to identify within the securities, opportunities for profitable buying, selling, or switching for the investor who holds, or is contemplating a holding in the securities so examined.
This year alone, the railroads will spend nearly $10 billion to add track, build switchyards and terminals, and open tunnels to handle the coming flood of traffic. Freight rail tonnage will rise nearly 90 percent by 2035, according to the Transportation Department.
In the 1970s, tight federal regulation, cheap truck fuel and a wide-open interstate highway system conspired to cripple the railroad industry, driving many lines into bankruptcy. The nation’s 300,000 miles of rails became a web of slow-moving, poorly maintained lines, so dilapidated in spots that tracks would give way under standing trains.
The Staggers Rail Act of 1980 largely deregulated the industry, leading to a wave of consolidation. More than 40 major lines condensed into the seven that remain, running on 162,000 miles of track.
But the changing global market has fueled prosperity — and the need to add track for the first time in 80 years. Soaring diesel prices and a driver shortage have pushed freight from 18-wheelers back onto the rails. At the same time, China’s unquenchable appetite for coal and the escalating U.S. demand for Chinese goods, means more U.S. rail traffic is heading to ports in the Northwest, on its way to and from the Far East.
Fuel costs certainly make the rails more economic if you are an operator of trains, while currently the truckers are hurting, with all sorts of problems within the industry.
However, the end users, those that actually have to pay the rail freight charges, are far from happy. The railroads’ rate structure has drawn the ire of some of their customers: Nearly 30 antitrust lawsuits have been filed against major railroads in recent months, including one by agri-giant Archer Daniels Midland last month, alleging collusion and price-fixing.
The funding required for this expansion is estimated at $148 Billion, $96 Billion from the rails themselves, the rest from the public purse.
Further, the railroads could not achieve the profits they say Wall Street demands without government subsidies. The railroads seek a tax credit, backed by Sen. Kent Conrad (D-N.D.), that would help them expand further.
More potential problems afflict the rails, the railroad industry’s long-standing antitrust exemption has attracted the attention of lawmakers. They seek to eliminate the exemption and closely examine the rates railroads charge to haul freight
Sen. John D. Rockefeller IV (D-W.Va.), whose state depends on trains carrying coal, introduced a bill last year that the railroad industry derides as the “Reregulation Act.”
The legislation, which has not been scheduled for a floor vote, would allow shippers to easily challenge railroad rates at the Surface Transportation Board, which regulates the rail industry. Now, some shippers say, they have almost no recourse if they think the railroads are gouging them.
It will behoove any investors to keep a close eye on the future legislation coming out that will obviously have far reaching consequences for this industry. Buffett obviously thinks that either it won’t matter, or he already suspects he knows the answer.
