Union Pacific Corporation (UNP), CSX Corporation (CSX): Should You Make a Bakken Oil Play With the Railroad Companies?

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CSX Corporation (NYSE:CSX)The Bakken play produces vast amounts of gas and oil that need to be transported, either by pipeline or railroad. Thus, as gas production expands, railroads can take advantage of the increased demand for their services. But at the same time, it causes people to use less coal, and hence, less of that needs to be shipped. As these countervailing forces  play tug-of-war, the railroads’ profitability — and hence,  the potential return on your investment — will be caught in the crossfire.

Currently, coal is a larger segment of most railroads’ shipping, and so 2012 was harder for the industry than 2013. The Bakken should continue growing, but even that implies a problem. The longer that growth continues, the more likely that pipelines will enter the area; according to Forbes, those pipelines charge $24 less per barrel than the railroads do. The other key here is that railroad companies are regional in scope, not national. Thus, some have more exposure to the Bakken, while others are more exposed to coal.

Source: The Association of American Railroads.

Burlington Northern Santa Fe, LLC (NYSE:BNI) is the most exposed. Sadly, though, Berkshire Hathaway Inc. (NYSE:BRK.B) owns the entire company, so you can’t directly invest in it. However, Berkshire Hathaway itself might be a good investment.

Not only does Berkshire Hathaway Inc. (NYSE:BRK.B) own one of the railways, but its tenth-largest stock holding is in ConocoPhillips (NYSE:COP), which, according to Bakkenshale.com, produced 24,000 barrels of oil equivalent per day in the last quarter of 2012 in the Bakken, and expects to reach 40,000 boe/d in four to five years.

Berkshire Hathaway Inc. (NYSE:BRK.B)’s conglomerate nature weakens its exposure to the Bakken, and hence, the potential upside — but also the resulting risk.

Union Pacific Corporation (NYSE:UNP) is perhaps the most direct bet on a railway in the Bakken. It focuses on western areas, as can be seen above. Thus, it is more exposed to the Bakken, and less so to coal, especially Eastern coal, which has a higher cost and hence more volatile.

Furthermore, Union Pacific Corporation (NYSE:UNP)’s financials are solid, and it is coming out of the Great Recession a leaner, meaner machine.We can see evidence of this in its most recent earnings release, with its operating ratio was up by 130 basis points, and its diluted earnings per share up by 9%.

Furthermore, revenue was up year over year in all of its major segments except for intermodal and agricultural.  The intermodal sector only fell by 1%, and the agricultural sector is heavily affected by the weather, making it less informative with regard to Union Pacific Corporation (NYSE:UNP)’s long-term potential.

Kansas City Southern (NYSE:KSU) is the other major publicly traded Western railroad. It is substantially smaller and less diversified than Union Pacific, and hence riskier. In addition, according to Yahoo! Finance, it is more expensive, with a P/E of 43.46, double that of Union Pacific’s 18.73.

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