(The following story by Brent Jang appeared on the Globe and Mail website on February 4, 2010.)
TORONTO — When shareholders of Burlington Northern Santa Fe Corp. next Thursday in Fort Worth, Tex., they will be saying farewell to the venerable railway’s listing on the New York Stock Exchange.
BNSF shareholders are poised to approve a friendly takeover bid from billionaire Warren Buffett’s holding company, Berkshire Hathaway Inc., clearing the path for the freight carrier’s delisting and placing the investment spotlight on North America’s five other major railways.
Berkshire, which owns 22.6 per cent of BNSF, announced its cash-and-stock offer last November to buy the rest of the Fort Worth-based railway for $26.3-billion (U.S.). Investors looking for a pure play on the railway industry have five other members of the Big Six to choose from: Canadian Pacific Railway Ltd., Canadian National Railway Co. Union Pacific Corp. Norfolk Southern Corp. and CSX Corp.
While Mr. Buffett described Berkshire’s offer for BNSF as “an all-in wager on the economic future of the United States,” investors also have the chance to place their own railway bets.
BNSF shareholders “bought a railroad and ended up with an insurance-heavy conglomerate, which is a different animal,” UBS Securities LLC said in a research note yesterday, referring to investors who will receive a portion of their proceeds in Berkshire stock.
BNSF has a total market capitalization of $34-billion, of which up to $17.1-billion will be available to be reinvested in other railways by institutional and retail investors, according to UBS.
RBC Dominion Securities Inc. analyst Walter Spracklin has examined which of the freight carriers look the most attractive, and his top picks for the rail sector are Calgary-based CP and Jacksonville, Fla.-based CSX.
An investment in CP amounts to a bet on China, potash and metallurgical coal. CP is hoping for China to secure long-term contracts with potash export consortium Canpotex. The railway is also counting on reaping favourable freight rates from Teck Resources Ltd.’s Elk Valley operation that produces metallurgical coal, which is exported to Asian steel mills.
CP has a price-to-earnings multiple of 10.8 times next year’s estimated share profit, a bargain compared with the multiple of 15.5 times in the BNSF transaction, Mr. Spracklin said in an interview. “Warren Buffett paid 15.5 times, and now investors can get the other rails for an average of 11.4 times.”
CSX looks undervalued with a multiple of 9.5 times, and the railway is positioned to transport increasing amounts of thermal coal, which is used by U.S. utilities, he said.
Mr. Spracklin has “outperform” ratings for CP and CSX. He likes the rail sector generally, noting that CN’s multiple is 13.6 times next year’s estimated share profit, Norfolk Southern’s is 11.1 times and UP’s is 11.8 times – all still lower multiples than what Berkshire is paying for the rest of BNSF that it doesn’t already own.
Historically, railways’ price-to-earnings ratios have traded at 10 to 15 times, but having weathered the recession well, the carriers appear headed to trade at multiples of 12 to 17 times, said Mr. Spracklin, who added that a smaller carrier, Kansas City Southern Railway Co., has a high multiple of 21.4 times because of a hefty takeover premium.
While the Big Six compete for business, they also have their geographical niches. BNSF and UP each have their own network of tracks in the western two-thirds of the United States, while CSX and Norfolk Southern operate east of Chicago and the Mississippi River.
CN and CP, which have extensive networks in Canada and the United States, could see year-over-year growth in 2010 in the volume of goods transported while enjoying “pricing power” in freight rates charged to customers, said Steve Hansen, an analyst at Raymond James Ltd.
Edward Jones analyst Brian Yarbrough said the railway industry will benefit from increased international trade by moving more “intermodal freight,” or goods transported inside standardized metal containers that are readily transferred between ships, trains and trucks.
“Intermodal transportation is widely viewed as rail friendly, since one train regularly hauls 100 or more containers, while a truck can haul one at a time,” Mr. Yarbrough said in a research note. “Rails’ fuel efficiency is typically two to four times better than trucks.”