Still Searching for Profitable Sectors

A couple of days of rallies in North American markets have not exactly renewed faith among investors, but at least some are more open to the idea of searching for what still may work out there. The basic premise is that just as the markets have dragged down “the bad” and “the ugly,” they have dragged down “the good,” too. As a result, there are plenty of solid companies, with significant growth potential, and with low P/E multiples to make them attractive to buyers on both sides of the border.

Today, I’d like to discuss the huffing and puffing of the railways companies, particularly the two largest ones in Canada, that have been working at a horrid pace to keep up with the surging demand for freight transport all across North America. It seems that nearly every aspect of the business process is impacted, from putting down new tracks to modernizing locomotives, old tracks and railway equipment.

Where is the demand coming from? Where else, but from shipping imports from emerging Asian economies all over Canada and the U.S., as well as from hauling our own commodity exports back to the same emerging economies. Why the railways? Simply because, compared to other means of transportation, such as the trucking industry, the railway industry retains its superior competitive advantage. In no uncertain terms, customers demanding to move their stuff via the rails are by far outpacing carriers’ capacities.

What improvements do companies such as Canadian National Railway or Canadian Pacific Railway have in mind and how much are those likely to cost? One of the problems that railway companies face is where to park their trains. Canadian National Railway invested approximately three hundred million dollars over the past few years to extend side tracks that are off the main lines to make the necessary allowances for other transport to travel without delays. The company has also spent about one hundred million dollars on rerouting tracks from urban centers to suburbs to further reduce traffic congestion and wait times at railway crossings.

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This is a no-brainer — surging demand is perhaps the best driver of growth. What also helps is the convenience, or having what economists refer to as a competitive advantage over other means of transportation. For example, from the cost of energy point of view, transporting goods on railways is three times more fuel-efficient and environmentally-friendly than using trucks. To give you an idea, one usual size freight train can carry cargo of approximately 280 trucks! Just imagine how much gas only one train saves and how much cleaner the air we breathe is as a result.

The two railway stocks I mentioned earlier appear attractive at the moment, trading at low trailing P/E multiples, having strong gross and profit margins, although debt vs. equity ratios leave something to be desired. On the other hand, this is to be expected from large companies investing new and earned capital in growth initiatives that have been spawned by the surging demand.