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Riding the (Small) Rails
RailAmerica (RA) is the largest owner and operator of short-line and regional freight railroads in North America. The Jacksonville-based company boasts a portfolio of 40 rail lines, with approximately 7,500 total miles of track in 27 U.S. states and three Canadian provinces. On any given day, the company is providing dedicated freight service to an Alcoa (AA) plant in Northern New York (on its four-mile-long Massena Terminal Railroad) or hauling farm products across Kansas and Colorado (on the 625 mile Kyle Railroad). RailAmerica also manages rail yards for industrial customers (“industrial switching”) and derives a decent amount of income from leasing land to cell tower/advertising billboard operators and from storing the rolling stock of other railroads on its network.
In 2009, the company hauled some 805,000 carloads of assorted freight and generated overall revenue of $410.6 million. It was modestly profitable, with adjusted share net, excluding one-time items, coming in at approximately $0.25 a share.
Asset management firm Fortress Investment Group (FIG) took the company private in February, 1997 only to sell a large stake (45%) back to the public 32 months later. Since the October, 2009 IPO, RailAmerica shares have underperformed both the broader market and its peers within the railroad group. Still, we think that long-term investors may be decently rewarded here, as company results and RA shares move higher with a resurgent rail industry and as RailAmerica firmly establishes itself as a consolidator within the short-line space.
The Only Game in Town
RailAmerica and other regional and short-line operators like long-time Value Line inclusion Genesee & Wyoming (GWR) are essential to the movement of rail traffic throughout North America. They’re the “on ramps”, if you will, to the long-haul networks operated by big Class 1 railroads such as Union Pacific (UNP) and CSX Corp. (CSX). Indeed, some 90% of RailAmerica’s overall freight volume interchanges with Class 1 carriers. Given the various hurdles facing new rail construction, established short-lines are also the only game in town for many industrial shippers looking to cost-effectively move bulk cargo. As such, the company has a fairly stable customer base and continues to realize upward pricing. It also stands to benefit from broader trends, including growth in global trade and the growing appreciation for the high fuel efficiency/low emission profile of railroads, vis-à-vis on-highway truckers.
RailAmerica is a decent investment play on continued consolidation within the short-line space. While additional mergers among the large Class 1 carriers aren’t likely due to antitrust issues, small players like RailAmerica may very well rely on acquisitions to enhance their growth. With that in mind, opportunities appear to be numerous. Within North America alone, there are nearly 560 short-line and regional railroads operating approximately 45,200 miles of track. The Class 1’s, in particular, may look to unload more of their short haul businesses, so that they concentrate on their core competencies.
The railroad industry faces the possibility of increased government oversight. Indeed, legislators are currently mulling a bill that would improve shippers’ access to regulatory relief. Late last year, Congress also let lapse a key short-line tax credit, leading to higher costs for the likes of RailAmerica and Genesee. Company-specific risks include those related to Fortress. As Fortress Investment Group remains RailAmerica’s majority owner, its interests may not be well aligned with those of smaller investors. Should Fortress ultimately elect to divest its remaining stake, the market supply of RailAmerica shares would also increase, potentially putting downward pressure on the stock price.