The North American freight rail industry operates as three duopolies, with two rail networks operating across the East, West and Central US into Canada. These rail networks have very high entry barriers, given the prohibitive cost and regulatory challenges associated with trying to lay a new rail network. More than half (55%) of rail industry revenue has no substitutes, while 45% of freight revenue could be substituted by trucking. Given this strong industry position, rail has been able to price above its cost inflation over the long term.
Three important factors make it an attractive time to invest in the rail operators. Firstly, the rail companies have implemented Precision Scheduled Railroading, a method of operating the railroad more efficiently, which should allow them to improve their service levels and lower their costs. Secondly, rail freight is four times more fuel efficient than trucking, and with higher fuel prices, its relative price discount to trucking increases further. Finally, longer-term, the increasing need for supply chains to decarbonise favours rail freight over trucking given its greater fuel efficiency. A 2% shift in volume from trucking to rail freight would increase the rail market size by 14%, given that the truck market is so much larger.
CSX is one of the two East Coast railroads, and its operating performance has been superior to its competitor Norfolk Southern. It trades at 14.3 times forward earnings, which should grow at low teens over the forecast period. This represents just a 5% premium to the MSCI All Country World Index forward multiple.