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Stock Strategist Industry Reports

Economic Moat Crossing Ahead: Railroads Advance to Wide

Railroads bolstered our confidence in the persistence of excess returns via solid performance through the recent recession and coal weakness.

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We have upgraded the six North American Class I railroad economic moat ratings to wide from narrow because of our increased confidence that the rails will continue to improve operating ratios, and consequently, returns on invested capital. In the past, we considered the railroads' excess returns too paltry to warrant assurance of long-run sustainable economic profit, but the railroads have demonstrated strong resilience through trials of recession-weakened freight and the decline in coal volume over the past several years. Based on this performance, we now are confident that rails will leverage their competitive advantages of low cost and efficient scale to generate positive economic profits for the benefit of share owners with near certainty 10 years from now, and more likely than not 20 years from now; by our methodology, this defines a wide economic moat.

Railroads Derive Economic Moats From Low Cost and Efficient Scale
Barges, ships, aircraft, and trucks also haul freight, but railroads are the low-cost option by far where no waterway connects the origin and destination, especially for freight with low value-per-unit weight. Moreover, railroads claim quadruple the fuel efficiency of trucking per ton-mile of freight and make more effective use of manpower despite the need for train-yard personnel, in part because of greater rail-car capacity and longer trains. Even for goods that can be shipped by truck, we estimate railroads charge 10%-30% less than trucking containers on the same lane.

Keith Schoonmaker does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.