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By TMFScarletGray
July 31, 2009

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The train index is still down. Warren loves Burlington Northern. But there other railroads as well. How would the Canadian National Railway compare to Burlington? It seems interesting to me because of the potential future devaluation problems for the greenback that may not be a problem for the loonie.

Hey Jan,

Back in June, I reviewed the last Q109 and the 10K for CNI. I haven't had time to review Q209, but I do know that I don't think the current price is very appetizing above $45/share. Here are a couple of my thoughts on Q109 quarter if it helps...

Final thoughts
I think CNI is a well run organization. Management stressed the efficiencies that they are trying to realize during this period. It seems that measures that were put into play last year are starting to pay dividends. This can be seen in an 18% faster train velocity over Q108, 26% more car miles per day over Q108, a 16% shorter dwell time in terminals over Q108. You can also see these efficiencies by looking at the operating ratio which is a comparison of the operating expenses divided by the revenues, which would have been below last years comparable if you exclude the EJ&E acquisition (lower is better). The operating ratio came in at 74.1% (excluding EJ&E 71.7%) compared to Q108 of 72.9%. You can see that management is pulling expenses out of the system by shelving locomotives, reducing the amount of equipment on rent, reducing head-count and trying to eek out every basis point of efficiency out of the metrics. They were fairly successful at pushing through price increases for the quarter which helped soften the blow in this down environment where we saw a 4% decline in rail revenues. This can be seen in the rail freight revenue/RTM metric which was up 12%.

My one concern with management is CEO Harrison stepping away from the position which I believe happened sometime during this past quarter. I haven't found the filed event describing his replacement, but I believe it was someone from inside the organization.

Time for Matt's crystal ball: The valuation doesn't seem nearly as tempting as when the share price was in the $30's. Using a very rough retained earnings model that I stole from Buffetology, I get the current share price offers somewhere between a 10%-12% appreciation rate going forward. I think a better price can be had during the back half of the year and I would get interested with a share price below $33.

I put together this next post on on CNI and some railroads in general back in January 2009 so it is a bit dated, but has some relevance...

Straight cut and paste from another board...

I have been curious about Warren Buffett's fascination with Burlington Northern Santa Fe (BNI). This has caused me to start poking around with a couple railroads and trying to figure out why Buffett is buying. As far as I can piece together, Bill Gates was the investor that told Buffett to take a solid look at railroads. Gates took his first position in CNI in the early 2000, which is about 500% not including dividends. I would imagine that Gates and Buffett have talked about railroads and he may be one of the reasons that Buffett started looking at them even further.

A little more color about Gates and Buffett:

Looking at Bill Gate's charitable investment arm, Cascade Investment, LLC, we can see that he owns 33.86 million shares. This totals to 7.2% of all outstanding shares of CNI.

I found this article about BNI which goes over some other topics on the railroad industry:

The couple items that I have found to explain Buffett's recent fascination with railroads would be:
1. Good (not great) return on equity. BNI's 5-YR ROE is 14%
2. Railroads look like they are still profitable with a low price of oil and are definitely lucrative in a high oil price environment. If one expects oil to be higher ten years from now, then an investment in railroads could be an interesting choice.
3. High asset costs create a large barrier to entry.
4. Possibility for consolidation (purely speculative on my part). Assuming that one could get around traditional trust issues, the largest railroad is BNI at 23 Billion with four other competitors above 10 billion in market cap.
5. Fairly repeatable business
6. Technology has increased speed, capacity and efficiency of the railroad industry over the past 5 years.
7. Cost of fuel can generally be passed onto the customer.

A couple negative things that I have found so far:
1. Unionized labor undermines some of the profitability of these companies.
2. Capital intensive business
3. Reliant on the commodity market. (Coal, Oil, Autos, and Agriculture)
4. Most companies have large debt load. (Personal preference to not have debt :)

A lot more that I have missed, but this is a sufficient start.

Here is a screen that I ran on that compares the largest companies. I decided to throw in GWR (a Hidden Gem) and GSH (a Pay Dirt Pick). Of the group, I am focused on evaluating CNI and BNI due to TMF and Warren Buffett's interests.

[See Post for Table]

That is all I have for now...I will be checking back as I get more time.

Matt W.