If you want to score a client in the railway industry, you can't do much better than Indian Railways.
India has the fourth largest railway system in the world, with more than 40,000 miles of track. Since the early 1950s, most of the country's railway services, passenger and freight, have been nationalized as Indian Railways. The company operates approximately 11,000 trains carrying more than 21 million passengers and 3 million tons of freight every day.
And General Electric (NYSE:GE) has just scored a $2.6 billion contract to provide 1,000 diesel locomotives to Indian Railways over the next 11 years. But while the deal itself is good, what it could mean for GE's future is even better.
This contract wouldn't have been possible just a couple of years ago. But last year, India allowed up to 100% foreign direct investment in its railway sector. This deal is the first to take advantage of this regulatory change.
Under the terms of the deal, GE will build a $200 million diesel locomotive manufacturing facility in the Indian state of Bihar, as well as maintenance sheds in Punjab and Gujarat, as part of the "Made in India" initiative, which seeks to highlight the country's potential as a global manufacturing destination.
Although it's the largest deal in GE's 100-year history in India, it represents just a drop in the bucket of Indian Railways' overall spending. This fiscal year alone, the company has allocated $15.3 billion just to maintain and upgrade its locomotives and other rolling stock. By comparison, Canadian National Railway (NYSE:CNI), another major GE client and a Class 1 North American railroad, only spent about $1.1 billion in total on its rolling stock over the five years between 2010 and 2014.
Other recent deals GE has made with foreign railways have been nowhere near as lucrative. The most recent such deal listed on GE's website is a $350 million deal to provide 100 locomotives to Angola over three years.
Canadian National Railway only received 60 new locomotives in 2014. But Indian Railways' deep pockets represent only part of the opportunity.
Riding the opportunity train
Indian Railways has been in the process of modernizing and upgrading its outdated infrastructure in recent years. And that spells opportunity for a company like GE.
For example, because of the haphazard way in which the country's rail lines were developed, there were four different gauges (sizes) of track used in various places. Indian Railways has been attempting to standardize the system by replacing other track sizes with broad-gauge tracks. Currently, broad-gauge tracks represent just under 80% of the entire system, which means that as broad-gauge tracks continue to replace narrower ones, the locomotives that run on those narrower tracks will have to be replaced as well.
In addition to replacing narrower-gauge locomotives, many of the country's existing broad-gauge locomotives are ready to be retired. Although current information isn't publicly available, a 1996 study indicated that more than half of the country's broad-gauge diesel locomotives were produced before 1970. The most common, the Alco WDM-2, had 2,600 horsepower. Compare that with GE's current line of Evolution diesel engines, which have 4,400 horsepower and meet stringent emissions standards to boot.
True, some of this aging diesel fleet could be replaced with electric locomotives. And indeed, Indian Railways has also been making a concerted effort to electrify portions of its tracks. But it plans to have only about 17,850 miles out of more than 40,000 miles of track electrified by 2017. And with oil prices cheap for the foreseeable future, it doesn't make much economic sense to rush to electrify long-haul diesel routes.
A long-term investment
GE Chairman and CEO Jeff Immelt called the deal "further evidence of India's position as a growth engine for Asia." Better yet, it's evidence of India's position as a growth opportunity for GE. It illustrates how GE can be competitive in high-growth markets worldwide.
Like GE itself, the Indian Railways venture will pay dividends. It gives GE a manufacturing footprint in the second-largest country in the world by population. Better yet, it initiates a relationship with one of the largest railways in the world: a railway that's growing its capacity by leaps and bounds. And having that existing relationship (and existing factory and workforce) will work in GE's favor when Indian Railways is looking for bidders on its next locomotive contract.
This deal is both a short-term and long-term winner for GE and makes an excellent case that its railway division still has a huge runway ahead of it.
John Bromels owns shares of Canadian National Railway. The Motley Fool owns shares of and recommends Canadian National Railway. The Motley Fool owns shares of General Electric Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.