As I've made clear in other pieces and commentaries, I'm a fan of short-line railroad operator Genesee & Wyoming (NYSE:GWR). Not only is Genesee more profitable than competing railroads, but the company has an enviable 10-year track record of nearly double the industry rate of same-rail growth. Yet despite all of that, these shares can be bought for a discount to almost all other railroad operators.
The fourth quarter was another solid report for Genesee. Revenue was up 30% in North America and 15% in Australia. Growth came on the heels of higher shipments of the company's bread-and-butter products -- commodities such as metal, coal, paper, and grain. Genesee, just like larger Canadian operatorCanadian National (NYSE:CNI), has prospered because the demand for rail transport of commodities has been hot and operators have been in a position of strength.
While higher diesel fuel costs and driver shortages in Australia pressured margins, the company still posted roughly 25% growth in net income, excluding certain charges. Free cash flow generation was also strong for the year, as it grew to almost $27 million in 2004 (vs. $26 million in 2003).
It should be noted that the company calculated its free cash flow in a slightly different way than I did, so its reported results will differ from my calculations. Namely, for 2004, Genesee included about $5.8 million in cash received from unconsolidated international affiliates, while I stuck with the more basic "operating cash flow minus net capital expenditures" formula.
Although the company's guidance for 2005 was a little weak, management indicated several times on the conference call that it was being conservative with its projections. For instance, although carload shipments for commodities have remained strong so far in the first quarter, Genesee is assuming essentially flat same-rail growth for the year.
Moreover, pricing assumptions seem conservative, and the company remains unhedged with respect to diesel fuel. Consequently, any meaningful declines from Genesee's forecast of about $1.55 a gallon in diesel costs will flow into higher operating profits.
The company also remains optimistic regarding the possibility of making additional acquisitions of small North American rail lines. While Genesee frequently encounters price competition on acquisitions -- most notably from short-line operator Railamerica (NYSE:RRA) -- it has one of the cleanest balance sheets in the industry. As a result, management won't have to worry about raising capital to close a deal.
Despite stronger operating margins and a better return on equity, Genesee shares trade at a discount to the railroad group. With a long record of solid growth and profitability, this company is clearly one of the better options in the transportation sector.
Fool contributor Stephen Simpson, CFA, has no ownership interest in any stocks mentioned.
