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Genesee & Wyoming on Fast Track

By Stephen D. Simpson
January 14, 2005

Regional and short-line railroad operator Genesee & Wyoming (NYSE: GWR) reported strong December and fourth-quarter traffic before the bell on Thursday. Fourth-quarter North American rail traffic was up 8.5% year over year, while Australian traffic increased by 4.2%. Traffic gains were driven by the company's core business -- hauling bulk commodity items like coal, coke, paper, grains, metals, and wood -- and are actually a bit better than they look, as last year's traffic was boosted by some unusual items.

Genesee & Wyoming just might be the best little railroad that hardly anybody knows about. Operating primarily in the U.S. and Australia, it focuses on regional shipment of bulk commodity goods. While this doesn't sound sexy, this is definitely the little engine that could (and does). Net margins are roughly 50% higher than the industry average, and management has been able to post double-digit returns on equity -- no easy feat in the railroad sector.

Best of all, Genesee & Wyoming has an effective monopoly on its customers -- in most cases it owns the rails that lead right up to the customers' doorsteps. The only other practical option for its customers in most cases is to ship their goods by truck, but given the sheer weight of the cargo and the low value-to-weight ratio, trucking isn't really a practical option. So unlike some of the major Class 1 carriers such as CSX (NYSE: CSX), Burlington Northern (NYSE: BNI), or Union Pacific (NYSE: UNP), Genesee & Wyoming doesn't have to worry about suicidal price competition.

What's more, the big boys don't really want to compete for the short-haul routes that are its bread and butter. This leaves Genesee & Wyoming with yet another advantage -- the ability to leverage a clean balance sheet to make selective (and accretive) acquisitions of additional small lines with relatively few competing bidders. Using a strategy of buying only when the return on investment is sufficient, the company has pieced together over 24 railroads and 8,100 miles of track into a very profitable business.

Though still small, the company is no longer dirt cheap, sporting a price-to-earnings ratio of 18.5 and an enterprise value-to-free cash flow multiple of almost 36. Still, revenue has grown almost 20% over the past four quarters, earnings per share have grown more than 37%, and structural free cash flow is growing even faster. What's more, the stock is trading at only 15 times next year's earnings; not bad for a company with a track record of better than 20% annual growth. As long as the economy keeps chugging, this is a stock that even Casey Jones could like.

Fool contributor Stephen Simpson has no financial interest in any stocks mentioned.