(Image source: WSJ)
Series of articles have been published for the past few months regarding railroad mergers. Here in November, here in December, here in January, here in February and here in March.
As a value investor, should one care whether Canadian Pacific Railway Ltd. (CP, Financial) would be successful with its Norfolk Southern Corp. (NSC) merger? Maybe.
Nevertheless, I seek facts between the companies’ financial data and see which among the big railroad companies are worth investing in.
Some railroad map visuals before proceeding with financial ratios: (Source:Ă‚ http://www.acwr.com/economic-development/rail-maps)
Just by images above, one can assume that probably the more routes involved in a railroad company’s operations, the more profitable the company could be. With this assumption, both Burlington Northern Santa Fe (BNSF) and Union Pacific Corporation (UNP, Financial) have the most routes.
(BNSF was acquired by Buffett’s Berkshire Hathaway in 2009 for $26.3 billion at 20 times its earnings then.)
Market Capitalization in USD Millions (FOREX 1 Canadian Dollar = 0.75 U.S. Dollar)
Profits
UNP appears not to have one competitor at the same level of raking in profits compared with its peers, except Berkshire’s BNSF.
According to the recent Berkshire Hathaway annual report, BNSF had profited a three-year average of $3.9 billion. UNP still earned more.
Profit Margin
Canadian National Railway Co. has been able to earn a quarter per dollar revenue, while other companies were able to earn 17 cents on a dollar given the 10-year period.
BNSF also performed within the group average for the past three years.
Capital Expenditures as a Percentage of Revenue
Kansas City Southern has been spending more than the peer average for its capital expenditures.
Free Cash Flow
Both Union Pacific and Canadian National Railway Co. exhibited big free cash flow. As a result, I expect these companies to provide better dividends over the years.
(Kansas City Southern has negative free cash flow in 2013 and 2014 with -$8 million and -$64 million, respectively. This finding may affect the average computation. Thus an investor must be careful calculating growth with negative numbers. Other than the aforementioned company, only Canadian Pacific Railway demonstrated negative free cash flow numbers. These negative numbers were from the years 2009 to 2011.
Canadian Pacific Railway has overcome its poor performance and become a free cash flow growth machine recently.
Share Buybacks Plus Dividends as a Percentage of Profit
It seems that the railroad companies did not stop paying their shareholders despite the occurrence of the Great Recession. Further, a conservative investor would like to see a company paying out their shareholders somewhere less than 80% of its profits or free cash flow.
In the chart above, Union Pacific, Norfolk Southern and Canadian Pacific appeared relentless in recent years in providing dividends and buybacks to their shareholders.
Share Buybacks Plus Dividends as a Percentage of Free Cash Flow
As a percentage of free cash flow, none of these Class I Railroad companies, but one exhibited conservative payouts.
Only Canadian Pacific Railway appeared to be conservative in this measure.
Debt to Equity
Only Union Pacific, Canadian National Railway and Kansas City Southern exhibited below peer average in terms of debt to equity ratio for the past decade.
Price to Earnings Ratio
Nevertheless, these railroad companies trade with mild discount to the S&P 500. CSX Corp. and UNP appeared to be the most discounted among the group. If I were to select my top pick among these top tier railroad companies, I would select UNP.
Disclosure: I am long UNP.
This is not a buy or an investment advice. Always do due dilligence.