2 min read.Updated: 06 Apr 2021, 05:31 PM ISTSpencer Jakab, The Wall Street Journal
Proposed merger of Canadian Pacific and Kansas City Southern, global transportation snags highlight the value of North America’s freight rail network
Trains were the Teslas of the 1800s.
Even after the wonder technology had been through multiple booms, busts and bankruptcies, railroads still made up more than half of U.S. market capitalization at the turn of the 20th century just as cars and planes were about to arrive on the scene. Their weight today is far more modest, but recent wobbles in the complex logistical web that delivers goods across the country and the world are a reminder of how valuable their systems still are.
Last month’s deal to create the first freight-rail network that would link Canada, the U.S. and Mexico is another. Canadian Pacific Railway, in its third attempt to hook up with a U.S. Class 1 railroad, said it would pay about $25 billion to acquire Kansas City Southern, the smallest of the major U.S. lines. The deal is likely to face a long approval process. Previous bids to merge with Norfolk Southern and CSX were unsuccessful.
Since Warren Buffett’s Berkshire Hathaway announced in November 2009 that it would pay $44 billion including assumed debt for Burlington Northern Santa Fe, the market value of North American railroads has risen sharply. That is despite a collapse in demand for the most lucrative commodity that they hauled prior to Mr. Buffett’s deal—coal shipped to power plants—and the fact that volumes have been sluggish for about three years.
An equal-weighted basket of shares of the remaining six Class 1 North American railroads bought the day before Berkshire Hathaway announced the deal would have had a total return of 862% through Monday compared with less than 300% for the S&P 500. Kansas City Southern, including the jump following announcement of its merger with Canadian Pacific, is the best performer over that time with a more than 1,000% return.
A successful deal could bode well for other players if it unlocks further consolidation. Analyst Bascome Majors of Susquehanna Financial Group notes that more deals could follow after 2022 if the official attitude toward consolidation has improved.
But even if the deal is blocked by the Surface Transportation Board, there are reasons to like railroads. A big one is the spread of precision-scheduled railroading—a management concept that has increased efficiency and train speeds but annoyed some smaller customers. Kansas City Southern’s operating ratio, a measure of efficiency, improved to 60.7% last year from 72.8% a decade earlier. And, as concerns mount over global warming, trains are well-placed to take advantage given their far greater fuel efficiency per ton mile than trucks for intercity freight. Railroads are also an excellent hedge against rising energy prices, truck-driver shortages or worsening highway congestion. More expensive diesel often leads to an uptick in rail traffic.
Railroads aren’t the bargain they were when Berkshire Hathaway pounced, fetching 24 times forward earnings on average, according to FactSet, compared with 15 times back then, but it is hard to see them becoming less important in coming decades. What Mr. Buffett said 12 years ago when he announced his rail deal remains true of the sector generally: “It’s an all-in wager on the economic future of the United States."