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Why This Railroad's a Great Bet for the Long Haul

Isaac Pino, CPA
March 12, 2013

Railroad stocks traditionally perform on-par with the economy: Periods of robust economic growth deliver attractive returns for railroads, and vise versa. For decades, this market-matching performance coupled with poor industry economics explained Warren Buffett's tendency to ignore the railroad sector altogether.

In more recent years, however, Buffett's experienced a change of heart, and it's not due to nostalgia for the bygone era of railroads. He sees a dynamic and profitable future for all of the major players, which could result in market-beating performance across the industry. This trend has already taken root and looks poised to continue due to steady long-term U.S. economic growth, a need for low-cost long-haul transportation of goods, and a rail infrastructure that remains the envy of the rest of the world. 

For investors, the door remains wide open for investment in rail, and CSX (NYSE: CSX), the largest East Coast operator, presents an attractive opportunity. To provide investors with further insight into CSX, we recently published an in-depth premium report that evaluates every aspect of the company from strategy to leadership to valuation. Today, you can get a sneak peak into this report and see just how CSX can use its valuable assets to deliver strong returns for shareholders in the years to come:

In May 2012, the International Energy Agency, a leading global alliance and research body, proclaimed the next few decades "the golden age of natural gas." The IEA predicted this clean-burning commodity will replace coal as the second-largest energy source in the world. As this shift rapidly takes shape in the U.S., especially among utility companies, financial pundits have proclaimed the end of the coal era as a major roadblock for certain railroad companies. What the pundits are missing, however, are a few noteworthy trends.

Coal's recent unpopularity in the U.S. might be temporary as natural gas prices rebound from their current rock-bottom levels. At the same time, coal is still a highly valued resource around the world, particularly in developing countries in Europe and Asia. These areas of the world have less immediately available natural gas resources, and thus any transition away from coal would take decades, not years, to play out. Let's compare the two trends taking shape currently in the most important coal markets.

For CSX, America's utility coal demand has steadily declined from its peak of 162 tons in 2006. During this time, many older, less efficient coal plants have been idled, and even the well-run plants have been forced to stockpile coal due to plunging natural gas prices.

CSX Domestic Utility Coal

In the meantime, the U.S. is emerging as a prime supplier of coal globally. As developed countries transition to cleaner fuels, the rapidly rising non-OECD countries in Asia, Eastern Europe, and Africa will drive the majority of growth in demand for coal.

World Coal Consumption by Region, 1980-2035

The long-term story of coal demand is quite different from the immediate repercussions of the U.S. decline. In the last five years, CSX's coal export loads have grown from 13 tons to 40 tons, or 207%. Demand in the developing world will boost trade, and in the end that's likely a positive trend for the U.S. Natural gas, a cleaner, cheaper energy source, could become the fuel that propels American GDP growth. Acting as a catalyst for the overall economy, natural gas can actually translate into growth for railroads as well.

Focusing so heavily on one critical aspect of railroads' long-term success can distract investors from an even more important development, recently described by The Atlantic magazine as "the insourcing boom." The return of manufacturing to America and the rise in exports is nothing short of revolutionary — yet many investors are