Saturday, September 16, 2006

Not IT - Are railroad companies the next private equity target?

Private equity firms, with a significant amount of capital to invest, highly incentivized managers (in case of buyouts like Sungard), the ability to avoid the cost of being a publicly listed, and the opportunity to extract operational efficiencies - are all reasons for the increased number of buyouts by private equity firms.

Typically, private equity firms are attracted to industries with consistent cashflows, low volatility (beta less than 1) , low debt (Debt less than 50% of capital) and high dividends. The railroad industry ( BNI, NSC, UNP) fits right into this set of specifications, and their enterprise values (market value of debt + market value of equity) are in the $24bn - $30bn range, an size that a consortium of PE firms can easily digest.

In addition, cash flows in this industry are strong, coupled with gross margins close to 40%. Railroads have a greater efficiency than road transport - and higher fuel costs are likely to make railroads cheaper than shipping by road. Levered beta for this industry (with 40% D/K ratio) is 0.9.

Stock values in the transportation sector have in general weighed down by high fuel prices, and railroads may be a good buying opportunity for PE firms.

Name
Burlington Northern Santa Fe Corp. CANADIAN NATL RAILWAY CSX Corp. Norfolk Southern Corp. Union Pacific Corp.
Industry Railroads Railroads Railroads Railroads Railroads
Current Share Price 69.82 41.02 31.61 43.05 83.80
Market Value $25,272 mil $21,851 mil $14,020 mil $18,711 mil $22,571 mil
Revenues $14,031 mil $6,507 mil $9,096 mil $9,107 mil $14,715 mil
Net Earnings $1,724 mil $1,684 mil $1,036 mil $1,343 mil $1,366 mil
5-yr. Sales Growth 8.24% 13.84% 1.41% 7.49% 2.89%
5-yr. Earnings Growth 15.23% 35.48% 25.08% 31.49% -0.53%
Net Profit Margin 12.30% 25.90% 11.40% 14.70% 9.30%
Short Interest 1.3 1.6 1.4 0.8 1.2
Est. EPS Growth Rate 15.3% 14.3% 16.1% 14.4% 15.6%
Forward P/E 14.1 14.2 14.4 12.9 15.0
PEG 0.92 1.00 0.89 0.89 0.96
Price/Sales 1.8 3.4 1.6 2.0 1.5
Price/Cash Flow 10.2 10.2 8.3 10.4 9.7
Price/Book 2.5 2.6 1.6 1.9 1.6
ROE 17.5% 22.2% 12.7% 14.2% 9.8%
ROA 5.7% 9.0% 4.3% 5.2% 3.8%
Dividend $1.00 $0.59 $0.40 $0.72 $1.20
Dividend Yield 1.43% 1.44% 1.27% 1.67% 1.43%
Payout Ratio 16.8% 16.6% 11.6% 18.1% 23.7%
Total Return (12-mos.) 18.2% 17.1% 37.7% 7.7% 18.5%
Total Return (3-yr.) 149.4% 143.4% 121.6% 140.4% 50.2%
Beta 0.8 1.1 1.0 0.9 0.8
% Off 52-wk. High -20.65% -19.84% -15.32% -25.40% -14.04%
% Above 52-wk. Low 26.07% 21.54% 48.06% 16.29% 25.28%
On Balance Volume Index 61 59 67 46 82