Railroads, robber barons of yore, and Monopoly (the board game) evoke several likenesses: of wealth earned via nepotistic monopolies, fat men smoking cigars lit with $100 bills, and the Wild West variety of frontier capitalism. And while oddly romantic, it just wasn’t true – 10 years ago, the railroad business more closely resembled the ragtag vagabonds that hitched a ride. Inefficient operations, infrastructure in disrepair, and unconsolidated end markets coupled to high reinvestment needs dogged railroads’ returns for decades.
But the past decade’s “Rail Renaissance” ushered a convergence between Monopoly and reality. After a rash of merger activity, roughly 90% of the nation’s freight moves across four railroads’ tracks. What seemed unfathomable a decade ago is now fact: Railroads are primed to earn high returns on invested capital, gain share from trucking, and sustainably increase prices.
That’s why I’m buying CSX Corporation (NYSE:CSX) – the freight railroad servicing almost the entire East Coast – for my Real Money Portfolio. Misplaced concerns over declining coal volumes, which represented 27% of CSX’s revenues last year, and a market that doesn’t appreciate the fundamental quality of its business, afford investors CSX shares at a mere 13 times earnings. Hop aboard.
The real-life monopoly
Originally born of the B&O Railroad in 1827, also a railroad in Monopoly (the board game), CSX currently operates a 21,000-mile track network, serving 23 states east of the Mississippi. Demographically speaking, it ranks among the most attractively positioned railroads, accessing the most populous regions in the United States – New York City, Chicago, DC, Atlanta, and Boston to a name few. In the year past, its most significant products (by revenue) were coal, chemicals, cars, and intermodal (moving containers or semi trailers).
As other Class I railroads, CSX Corporation (NYSE:CSX) benefits from formidable competitive advantages. Because the cost of duplicating CSX’s track network numbers untold billions, and obtaining rights of way harder than pushing a needle up stairs, would-be competitors face almost prohibitive barriers to entry. Likewise, because it owns a huge, geographically concentrated track network, it benefits from significant network effects: An incremental mile of track, or an additional carload, can add outsized value to the bottom line.
In the past decade, railroads have, increasingly, employed technology and operational know-how to their advantage: packing cars full on both legs of a trip, double-stacking them, and running longer trains. This, tied to oil’s move north of $80 per barrel – a circumstance unlikely to change – has afforded rail a tremendous cost advantage to trucking. By Burlington Northern Santa Fe’s math, rail is three times more fuel efficient than truck. Incumbent competitive advantages in hand, it’s provided a license for Class I rails to increase prices at a 4%-5% clip. The numbers speak volumes: Operating margins at Berkshire Hathaway Inc. (NYSE:BRK-B)‘s Burlington Northern Sante Fe, Union Pacific Corporation (NYSE:UNP), Norfolk Southern Corp. (NYSE:NSC), and CSX have improved by more than 10 percentage points. That’s not a typo.