Introduction to Investing in Railroad Stocks Part 2: Union Pacific vs. Norfolk Southern – Which is Better?

You may remember several months ago I began a series on railroad stocks, introducing you to the idea, what they do, the sector they’re best tied to and how the market treats rail stocks. Now that we have that background we can begin to look at one of the most contested and argued questions in rail stocks, “who’s the best railroad in America?” Of course that question gets asked a lot and the two rails that are continually mentioned in that question are Union Pacific in the west and Norfolk Southern in the east.

Cargo Disadvantages and Intermodal Freight Advantages

The percentages of what a rail transports, otherwise known as cargo are very important to its short term price but perhaps less important to the long term. This is due to the immense power of intermodal freight which allows the company to have some flexibility regardless of what commodities prices are. Ties to coal are the most common weakness in this sector however being under 50% with a healthy diversity of other products makes UNP more appealing than otherwise. Norfolk Southern Corporation is having a bit more trouble handling the declining demand for coal as their reliance on it is slightly higher near 30%.

Analysts expect a long term replacement for the weakness in coal right now with either a resurgence in coal or the reliance on the two railroads in the fraking industry for oil. Two of the biggest spots are Utica Ohio which Norfolk Southern has a direct line to and the Bakken in North Dakota for which UNP can take advantage of. Each of these have a long term lifetime and each will demand a generous supply of fraking materials such as blast sand. Neither may be a true replacement but it proves the railroads willingness to adjust to the economy, something they have been quietly doing for decades.

Acquisitions and Interaction with Shortline Rails

Size is always a problem in the rail industry in regards to the government’s Sherman Anti-Trust Acts which are in place to prevent virtual monopolies from existing. The railroad industry has long been a victim and suspect in these and UNP is no exception. For shareholders this translates as a highly unlikely chance for growth or acquisitions. In fact, acquisitions are largely a thing of the past for railroad companies.UNP is located in a region of the United States with far fewer short line rails, competing and working with BNSF and G&W.

Whereas, the east cost and Great Lakes regions still maintain a number of shortline rails.  These are the companies that are often private, providing regional and short line services to from the industrial powerhouses and rails of NSC and CSX. Think of them as the go between or middleman. Most were purchased before the 21st century and only a small list exist outside of small pockets in regional America. Nevertheless, if acquisitions would occur, Norfolk Southern would likely be in the best position to take advantage of them. If congress would ever allow it, CSX would be an awesome takeover target for NSC.

Competition – One has a huge Advantage

Believe it or not, UNP’s biggest competitor is Burlington Northern Santa Fe not Norfolk Southern, purchased outright by Warren Buffet’s Berkshire Hathaway. The confusion is that because the two behemoths are considered the best rails they are competing with one another, which is not true. Both operate in arguably separate markets. BNSF, operates among many of the same rails as UNP and the two are actually on terms to share lines and even cars. I would expect these relationships to last long term but someone will have to pay up when restructuring and new lines are needed. Nevertheless both are in a position to do so with positive free cash flow.

Rather than work together NSC and CSX are in direct competition over almost the exact same territory and although many would give NSC the advantage, CSX is no laggard and are definitely improving their margins to be far more competitive and consistently profitable for consecutive quarters, compared to NSC’s more disappointing quarters.

What’s the Verdict – Who’s better: Norfolk Southern or Union Pacific?

The answer is not easy. Both rails are more expensive than they were a decade ago after people finally learned of the value in rail transport. However both have been hit as of late from the declining demand in coal. Neither of these are as important as the competitive advantage each has both as rail stocks and as individual companies. Consider geography here too. NSC will have far more competition on the eastern half of the United States whereas UNP acts largely without consequence in the west.

UNP clearly has the largest mileage of track and the largest revenues. In addition, NSC has a growing amount of debt which factored into spending translates into negative free cash flow. With that in mind, investors can choose Union Pacific as the best here based on fundamentals or metric or they can decide that NSC is not only cheaper per share but has a lower P/E ratio with some potential growing room. Many will ignore both of those and favor geography as their deciding factor so as to diversify. Finally, a growing number of investors are acquiring both companies as a track record of the American economy.

Tagged BNSF, coal, CSX, dividends, Norfolk Southern, NSC, railroads, shale, transportation, Union Pacific, UNP