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Genesee & Wyoming (GWR) is a short-line railroad operator that has interests in over 100 freight railroads worldwide. The majority of the company’s railroads are located in the United States, but it also has networks in Canada, Australia, and Europe. The railroad hauls everything from coal, cars, metals, to electronics, farming equipment, and petroleum products. G&W works with just about every Class I railroad in the U.S., including Union Pacific (UNP) and Norfolk Southern (NSC), to name a few.

The company reports revenue under 12 business categories. In fact, the railroad derives no more than 10% of its sales from any one division. The intermodal unit has experienced some nice growth in sales over the past couple of years. The recent acquisition of Australia-based FreightLink in 2010 has boosted the top-line performance in this segment.

The coal business has historically been a profit driver, driven by demand from power operators. That said, tougher regulations on new and existing plants, natural gas competition, and softer utility and export activity ought to weigh down volumes in the coming years. Conversely, the Food and Farm Products division should pick up, largely due to stronger demand from domestic and emerging markets. 

Crude By Rail

We believe the biggest growth driver for the industry will be the transportation of energy. In particular, there should be a number of opportunities to haul crude oil and natural gas, given the activity levels in many of the North American shale plays. Though pipelines will start to eat into market share, we expect railroads will remain a strong competitor in the coming years. We imagine railroads will offer a certain amount of flexibility for oil & gas operators and should remain a major factor in this market.

International Operations

The company has some decent growth drivers, despite an uncertain mining environment, in both Canada and Australia. In Australia, the short-line operator signed a contract with Arrium Limited to export an additional 2.7 million of iron ore tons per year to the southern part of the country. The company has been invested heavily in upgrading rail lines and wagons for the expected ramp in production. In Canada, one of G&W’s subsidiaries signed an agreement in the middle of last year with Tata Steel for the transportation of iron ore. We are still optimistic on these contracts, due to resilient demand for iron ore in China.

Acquisitions

The company made some noise in the industry last year with its purchase of RailAmerica. G&W paid an 11% premium for the short-line operator, receiving regulatory and shareholder approval at the end of 2012. Genesee & Wyoming is still going through the process of integrating RailAmerica’s rail lines, cars, and equipment. In fact, the company has realized about $40 million in cost savings to date and will likely find additional savings in the coming quarters.

We expect this acquisition to bear fruit going forward. RailAmerica served many regions of the country where G & W had limited or no exposure whatsoever. In particular, the Midwest and the West Coast will help further diversify its customer base. In addition, RailAmerica was more exposed to the chemical and agriculture industries, which have stronger long-term fundamentals.

Legislation

The company is lobbying Congress for a more permanent extension of the short-line tax credit that was set to expire at the end of 2013. The legislation allowed smaller rail operators to claim a tax credit of 50 cents on every dollar spent on track infrastructure. There is solid bipartisan support for the bill, with 175 in the House and 35 in the Senate endorsing the proposal. Given the strong consensus among the opposing parties, we expect either an extension or more permanent resolution in the new year.

Recommendation

Favorable trends in the intermodal, agricultural, and energy markets should help the company sustain solid bottom-line growth in the coming years. In addition, the integration of RailAmerica ought to yield nice returns going forward. Consequently, this stock currently offers above-average longer-term capital appreciation potential for buy-and-hold investors. All told, we think these shares are suitable for a well-diversified portfolio. 

For more information regarding G&W’s long-term prospects, as well as how the stock responds to the RailAmerica integration, subscribers are encouraged to check out our full report in The Value Line Investment Survey.

At the time of this writing, the author did not have any positions in the companies mentioned.