CSX Corporation (CSX), Norfolk Southern Corp. (NSC): The Single Biggest Risk Facing Railroads Today

Better in Canada?

Compared to U.S. railroads, Canadian railroads do not transport substantial coal volumes. Coal accounts for just 7% of Canadian National Railway (USA) (NYSE:CNI)’s revenue, making it relatively immune to the natural-gas revolution.

However, despite avoiding major exposure to coal, Canadian National Railway (USA) (NYSE:CNI) derives 14% of its revenue from forestry products, which are in a secular decline. Taken together, coal and forestry account for over one-fifth of the company’s revenue, which could lead to a major earnings disaster in the future.

But, with an industry-best operating ratio and ample free cash flow production, Canadian National Railway (USA) (NYSE:CNI) has much more room for error than CSX Corporation (NYSE:CSX) and Norfolk Southern Corp. (NYSE:NSC). At a 17.9 earnings multiple, Canadian National Railway (USA) (NYSE:CNI) is much more attractive than either of the coal-dependent railroads due to its track record of low-cost operation and high returns on assets; the company earned a 10% return on assets in 2012, a figure virtually unheard of in an industry where debt usually drives return on equity.

Bottom line

The transition from coal to cheaper and cleaner fuels will occur in a drawn-out process that will take many years — maybe even decades. However, the headwinds that it creates for companies like CSX Corporation (NYSE:CSX) and Norfolk Southern Corp. (NYSE:NSC) will be a constant reminder of each company’s inability to generate substantial revenue growth. Investors in all railroads — but especially those that rely heavily on coal — should be mindful of the inevitable decline of coal.

The article The Single Biggest Risk Facing Railroads Today originally appeared on Fool.com and is written by Ted Cooper.

Ted Cooper has no position in any stocks mentioned. The Motley Fool recommends Canadian National Railway. Ted is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.

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