West American Railroad Industry
Rail still handles most freight
But few people know that railroads, the industry that Union Pacific belong to, are still responsible for transporting 30% of the goods used in the United States each year, which shows that this is a large proportion. It may not be glamorous, but it’s big business. Railways exist in a very special environment. In a word, there really can never be new market entrants, at least not new rail market entrants.
Barriers to entry are too high
There’s no way any company would want to rebuild the Class 1 rail network built over the past 150 years, as it’s estimated to cost trillions of dollars, and that figure doesn’t even include land acquisition costs. This is the barrier to entry for creating a new railroad company, and the numbers are astronomically large.
Only two companies monopolize the industry
In North America, it’s almost synonymous with railroads, with 32,000 miles of railroad tracks. Stretching across the Great Western United States, two railroad companies operated as a duopoly. The two railroads, BNSF (Burlington, Northern Santa Fe) and Union Pacific (UNP), formed the Northwest Territory monopoly. The Burlington Northern Santa Fe Railroad has been acquired by Berkshire.
Union Pacific (ticker: UNP) is a railroad company and one of the largest railroad companies in the United States. Railroads are not, in my opinion, the most progressive industry, nor one with much potential for growth.
So it’s really a protected industry and there won’t be much competition. Maybe you could say that there are other types of competitors, that is, other types of ships; ships, planes, and other types of ships. But for 30 percent of all freight transported in the United States, railroads are the only option, and Union Pacific is arguably the biggest of them all.
Berkshire has its rivals
In the shadow of the Great Recession in late 2009, Berkshire acquired the Burlington Northern Santa Fe Railroad (ticker: BNSF). Buffett mentioned in his 2015 shareholder letter: “BNSF accounted for 17% of the US intercity freight market in 2015.”
Union Pacific has $10 billion in operating income. They do have $35 billion in debt. Again, let’s focus on the balance sheet.
123 consecutive years of dividend payment
Union Pacific is a very good company with a 2.7% dividend yield. Most people are probably looking at the railroad’s dividend yield. But they have paid a common stock dividend for 123 consecutive years. That’s certainly the kind of stability some more conservative or older investors are really looking for.
After 123 years of consistent dividend payments, I can imagine Union Pacific spending a lot of cash flow on those dividends. At the same time, many of the railroads we see in the news, including Union Pacific, are having talent and some safety issues.
Capital Allocation and Strategy
In general, the industry has had to clean up a litany of security issues that have only really popped up in quite a big way recently. This is mainly for safety reasons, but also because we don’t want continued interruptions in the movement of goods across the country. But I think it’s mostly for safety. Let’s be careful.
In terms of capital allocation, they returned about $10 billion to investors last year; $7 billion of that was through share buybacks and about $3 billion through dividends. Dividends, I’m always a little bit tricky with share buybacks because you want to make sure they’re buying shares at an attractive price for shareholders, especially at that level.
Repurchase could erode safe investments
I’m going to have to dig a little deeper to see if 7 billion is the right number. This seems a bit high. They need to undo that and increase their capex, especially to address some of these security issues that we discussed. The stock has an activist investor who is primarily calling for a CEO change, so all that comes out of that is improving operating metrics and improving the overall business.
Average price-to-earnings ratio
This is another company with a relatively low PE ratio of 17, but it’s not unique. Other railway companies listed on the US stock market: CSX Transportation Company (ticker: CSX) is 16 times, Norfolk Southern Railway (ticker: NSC) is 15 times, and the Canadian National Railway Administration (tickere: CNI) is 20 times. They are all in the 15 to 20 range. Not very high, it can be seen that Union Pacific’s price-to-earnings ratio is at an average level.
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