The Cash Cow With A 20,000 Mile Advantage
A few years ago, I had the opportunity to visit the palatial Biltmore Estate in Asheville, North Carolina. Built near the turn of the century to rival the grandest European manors, this stately five-story mansion is the nation’s largest private residence.
Commissioned by George Vanderbilt during the Gilded Age, the Biltmore was an open display of opulence and wealth. At a time when many homes lacked basic electricity and indoor plumbing, this one featured an elevator, gymnasium, library, pipe organ, billiards room, heated swimming pool, bowling alley and walk-in refrigerator.
The Biltmore Estate in Asheville, North Carolina
The impeccable grounds outside were equally impressive. The country chateau was located in the scenic Blue Ridge Mountains, surrounded by acres of lush flower gardens, vineyards and tree-lined pathways.
Two generations earlier, George’s grandfather, Cornelius Vanderbilt, took control of the New York Central Railroad, the Michigan Southern Railway and several other lines, eventually building an empire worth $143 billion in today’s dollars — making him the second-richest man in history.
That was a different era, of course. Railroads seem quaint these days next to driverless cars and other 21st century technologies. But don’t be fooled. They remain the cheapest way to move mountains of coal, lumber and other commodities across the country — which is why after all these years, today’s richest business tycoons are still following in Vanderbilt’s footsteps.
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The More Things Change, The More They Stay The Same
Between the time you woke up this morning and the time you go to bed, about 9 million barrels of oil will be produced in the United States. Another 9 million will gush to the surface tomorrow.
But here’s the thing with all that oil — it’s pretty much worthless if it can’t be shipped to a refinery.
Most of the nation’s refining infrastructure is clustered along the coastlines of Louisiana and Texas (easily accessible by overseas tankers). But Mother Nature didn’t conveniently deposit all of our crude there. It might be shipped in from as far as North Dakota and Montana, where the bountiful Bakken Shale is located.
Production in this hotspot skyrocketed to 1.2 million barrels per day. But in recent years, there has only been enough pipeline capacity to haul away around 400,000 barrels. That means twice as much (800,000 barrels per day) has been transported by rail from production grounds to refining hubs.
#-ad_banner-#And that’s just in one oil play. Across the nation, the amount of crude oil loaded by railroad exploded from 9,500 carloads in 2008 to 493,000 carloads in 2014. That’s an incredible surge of 5,100%.
And consider this: crude oil accounts for just 1.5% of total railroad freight volume. So this is just a tiny piece of the puzzle.
Railroads are the workhorses of the economy. Pound for pound, railroads use less fuel and are four to six times more energy efficient than trucks. One train can haul as much freight as 280 trucks. And believe it or not, an average train can move a ton of freight 470 miles on a single gallon of fuel. That simple fact explains why railroads are just as vital (and profitable) in the 21st century as they were in the 19th.
We’ve already talked about oil. But it’s only one of the commodities shipped in huge quantities by the rail system. Each year railroads haul 36 million tons of wood products, 44 million tons of steel, and millions of tons of other construction aggregates being used to expand U.S. infrastructure. Trains also carry enough coal to power 78% of U.S. households and completely support the transportation of ethanol, which can’t be transported by pipeline. Other cars carry our food and the chemicals used to grow it.
And regardless of whether prices for oil, fertilizer, lumber and other products are up or down, the railroad gets paid to move them just the same. So this is an ideal way to profit from rising demand and consumption without being whipsawed by volatile price fluctuations — the hallmark of the type of “Pick and Shovel” business we look for at Scarcity & Real Wealth.
Tying It All Together
So… 241,000 carloads of lumber. 489,000 carloads of steel. 755,000 carloads of crushed stone. It adds up.
Last year, the nation’s railroads hauled a total of 26,587,351 carloads of freight. That traffic is tied to the health of the global economy, so volumes might dip 5% to 10% in a weak cycle. But it’s a generally steady business on an upward path.
The compensation to move all this stuff varies by product, geography and other factors. But the Surface Transportation Board, a government oversight agency, figures an average rate of $3,153 per car.
We’ve been talking a lot about infrastructure lately as the White House gears up to push a $1 trillion spending initiative to rebuild roads, bridges, dams, water pipes and other public works. Well, you can’t do that without tons of I-beams, rebar, concrete and steel — most of which is moved by railroad.
Better still, there are daunting barriers to entry in this industry, not the least of which are right-of-way permits to build new lines. So railroads often enjoy something of a monopoly on their turf.
Even before this massive catalyst appeared, the world’s wealthiest investors already connected the dots and saw huge potential in railroads. The most famous example was Warren Buffett, who in 2010 spent $34 billion to take control of Burlington Northern Santa Fe. Even by Berkshire Hathaway standards, this was a big investment — the biggest bet of Buffett’s illustrious career.
At the time, he referred to it as an “all-in wager… that we’ll have more people moving more goods 10 to 20 years from now.” Buffett has also invested in Union Pacific (NYSE: UNP) and Norfolk Southern (NYSE: NSC), as well as a railway equipment leasing firm called Union Tank Car, whose roots trace back to John Rockefeller’s Standard Oil.
And he’s not alone.
Most people don’t know it, but Bill Gates has also made sizeable investments in railroads. It’s no accident that two of the world’s richest, smartest, and most successful investors both have huge positions in railroads. Today, we’ll be climbing on board and joining them.
Moving 300 Million Tons Of Cargo Every Year
I didn’t choose my railroad pick for the chance to bump into a billionaire at the next shareholders meeting. My decision was based on a thorough evaluation of each of North America’s railroads, from which this company emerged head-and-shoulders above its peers. Still, it’s always reassuring to be in good company.
This Railway owns 20,000 miles of track that stretch across the entire continent from Vancouver to Halifax and down to New Orleans in a big “T” shape. This is the only railroad whose operations extend from the Atlantic Ocean to the Pacific to the Gulf of Mexico. That geographic reach is a huge advantage, particularly when it comes to intermodal shipping.
This company deals in all eight of the primary commodity groups outlined above, as well as others we haven’t even talked about yet such as frac sand and industrial metals (aluminum, zinc, iron ore, etc.). Unlike other railroads that depend heavily on coal, my pick generates a scant 6% of revenues from the black rock. So it’s less exposed to shrinking coal volumes.
Instead, the company deals primarily with petroleum, chemicals, grain, fertilizer, lumber and minerals, which account for more than half of revenues. All told, this railway hauls nearly 300 million tons of cargo each year.
Even better, this railroad moves cargo more efficiently than its competition. In fact, it’s operating margin (which measures expenses as a portion of revenues) is better than its nearest competitor by more than 6% This, in turn, increases its profit margin, driving cash flows that can be reinvested or returned to shareholders.
This is a capital intensive industry, and management spends a good deal of cash each year maintaining its track infrastructure and upgrading equipment. Still, management maintains a very healthy margin. Record free cash flows in 2016 enabled the company to hike its dividend (by 20%) for the 22nd straight year. All this in a year when overall railcar traffic dipped 5%.
But rebounding commodities markets, busier oil and gas drilling, stronger manufacturing and other macro tailwinds should help buoy freight numbers going forward. And yields — best expressed as revenues earned from moving a ton of freight one mile — should firm up as well.
Beyond that, general economic strengthening promotes global trade, which means more “stuff” that needs to be moved from farms and factories to cities and from port to port. As the most profitable and well-positioned railroad, this company should be a prime beneficiary.
“Pick And Shovel” Investing In The 21st Century
Today’s billionaires, like Cornelius Vanderbilt and John D. Rockefeller before them, recognize the same truth: Investing in safe, steady payouts is a better way to build wealth than relying on volatile commodities. And the best way to access these returns is by investing in the “pick and shovel” companies. That is, by buying those companies that benefit from surges in commodities, but are steady and adaptable enough to get by without them.
Like the merchants who made a fortune selling picks and shovels in the days of the Gold Rush, today’s railroads pipeline companies, among others, stand to make a fortune off of increased commodity production and consumption. Trends are lining up such that these companies, particularly my railroad pick from above, could see double-digit gains this year alone, with even more growth slated for the years ahead.
But out of respect to subscribers of my premium newsletter, Scarcity & Real Wealth, I am not going to share the name of this railroad giant here. If you want the name of this company, as well as my other picks for companies perfectly positioned to benefit from the coming commodities “gold rush,” I invite you to click here.