Investors Take A Sudden Interest In Railroad Business

Chris Mayer - Thu 05 Jul, 2007

In the U.S., several savvy investors have taken a sudden interest in the good old railroad business. Warren Buffett recently bought stakes in three freight railroads: Burlington Northern Santa Fe Corp., Union Pacific Corp. and Norfolk Southern Corp. He was not alone. But those surviving railroads are making big profits. "Strong demand for coal, agricultural and container services - the 'holy trinity' of freight - has trains running at full steam," says The Economist. The railroads gush cash, some of which they pay out in higher dividends and to buy back stock. The rail renaissance is on...

Experts called it the most difficult project in the
history of railways.

Imagine it. Chinese engineers laid 690 miles of track
from Golmud, in the Qinghai Province, to Lhasa, the
capital of Tibet. They did it in less than four years. In
typical Chinese fashion, that was three years ahead of
schedule. About 38,000 workers advanced more than half a
mile a day. At times, they had to tunnel through ice and
rock with temperatures as low as 31 degrees below zero.
Swiss engineers, who have some expertise in matters of
tunneling through mountains, thought no one could get
through the Kunlun mountain range. The peaks of Kunlun
wear snow hats year-round. Passes weaving through the
range still climb more than 15,000 feet. Oxygen is at a
premium up there. Then there is the steepness of the
grades the trains must climb. They are steeper than any
railroad anywhere in the world.

Yet the Chinese have their railroad, and more are on the
way. China has more than 32,000 miles of track. The
Chinese ambitiously add to that total every day. Demand
for rail service is high. During peak season, China's
rails carry more than 5.2 million passengers a day.
In the last week of May, China introduced its first
bullet trains - 280 cars capable of traveling up to 155
miles per hour. Now you can get from Beijing to Shanghai
in 10 hours, instead of 12. Tickets sold out quickly.
China's railroad revival is not unique to China.
All around the world, it's becoming clear: The rails
are back.

In the U.S., several savvy investors have taken a
sudden interest in the good old railroad business.
Warren Buffett recently bought stakes in three
freight railroads: Burlington Northern Santa Fe
Corp., Union Pacific Corp. and Norfolk Southern Corp.
He was not alone.

Billionaire and fellow investing legend Carl Icahn also
picked up some railroad shares. He bought a $122 million
stake in CSX Corp. King Carl's interest in the railroad
story runs deep. He is also chairman of American Railcar
Industries Inc., a manufacturer of railroad tank cars.
What's especially interesting is that these old warhorses
- famous bargain hunters, both - took their positions as
these stocks were making new highs. The Standard & Poor's
500 railroads index has more than doubled since the end
of 2002. It's up another 23% in 2007 as I write.

As The Economist recently noted: "It's been a long time
since railways have become so fashionable." The ever-
sober magazine recounts bits of the railroad industry's
sad history. Railroads were once the dominant choice for
intercity traffic, with 75% of the market as late as
1929. By 1980, that share fell to 38%, as new roads and
trucks ate into their share of the pie. About a third of
railroads lost money. Deregulation, begun that year, set
off a 20-year period of restructuring and consolidation.
Only seven of 31 Class I railways survived this lengthy
and brutal bear market.

But those surviving railroads are making big profits.
"Strong demand for coal, agricultural and container
services - the 'holy trinity' of freight - has trains
running at full steam," says The Economist. The railroads
gush cash, some of which they pay out in higher dividends
and to buy back stock. The rail renaissance is on.
Some of this story links to China, as these things always
seem to these days. Railroad companies are busy laying
track and building terminals to accommodate tens of
thousands of containers coming into this country every
day - many from China. We are in the midst of a great
cargo boom, the effect of which also extends to the
rails. More and more of that freight gets loaded on
railcars, as opposed to a truck trailer.

Trucking costs are high. Truckers struggle with the high
prices of gasoline and diesel - trends not likely to
reverse anytime soon. High oil costs hit trucking much
harder than they hit railroads, which are three times
more oil efficient, as Buffett has pointed out. Trucking
companies have difficulty finding long-haul drivers and
face high insurance premiums. Increasing gridlock in most
cities makes delivery a little less reliable.

Another reason for the rail revival: the rise of cities.
We are at a tipping point in world history: By the end of
this year, more people will live in cities than not. Many
of these cities suffer the same problems: congested roads
and lack of urban land.

Therefore, there is a growing premium on urban space.
Cities and developers must look at better ways to use
existing space. Increased reliance on rail helps this
effort. Rail delivers large numbers of people and freight
without taking up much precious urban land, as compared
with accommodating increased car or truck traffic - or
even building an airport.

The rails also help stave off gridlock on the overcrowded
roads of the world's cities. More traffic by rail may
absorb people and freight that otherwise would have gone
by car or truck.

The rails appease the green crowd, too. Air travel is a
big polluter. Flying results in twice as much air
pollution as traveling by rail. Airlines also struggle
with the high cost of fuel.

All of these reasons factor into the railroads' recent
popularity with investors. You could go out and buy any
of the railroads yourself and gain exposure to this
trend. Take a ride along with Buffett and Icahn and other
savvy investors who are also buying railroads.

There is always a crisis somewhere at some stage of
development - some just beginning, some in bloom and some
just ending. In the case of the railroads, it looks like
their long stretch of troubles is over. The rails are
back.

Regards,

Chris Mayer
For The Daily Reckoning

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