Union Pacific shareholders had a great 2010.
One of the many things that America has given the world is "The Western", a genre of tales about the 19th century Wild West where the heroes are men and women who are typically armed with a trusty old revolver and a strong sense of justice.
Nowadays the gunfighters have gone, though some might argue that they've been replaced by lawyers, and the wagon train is now a Winnebago, but at least one symbol of the Wild West, the railroad, is still doing business, just as it has for over 150 years.
The biggest railway in the United States of America is Union Pacific Corporation. Last week, Union Pacific posted record profits, with earnings per share for 2010 rising by 48%.
In recent years, America's railroads, and their shares, have had a new lease of life as high oil prices have made it much cheaper to move long-distance freight by train than by truck.
The great American railroad
Union Pacific was founded in 1862 to build railroads west of the Missouri river, connecting to the Pacific coast, in order to keep the Union Army supplied during the civil war. The Great Transcontinental Railroad was finished in 1869, when Union Pacific met the Central Pacific Railroad of California Railroad at Promontory Summit, Utah.
Although Union Pacific was bankrupted in 1870 and 1893, in its current incarnation has managed pay dividends in each of the last 111 years. There aren't many companies that can say that!
Whole industries have come and gone during this period and Union Pacific continues to haul freight across the western United States, making money for its shareholders.
Buffett likes the railways
The railroads suffered badly in the late twentieth century, as strong competition from trucking industry ate into their business. But high oil prices have changed all that. Today it's cheaper to haul freight using railroads, except over short distances.
Union Pacific is the kind of company that Warren Buffett favours because it provides an easy-to-understand product (haulage) that is essential to modern society, whilst it has a strong "moat" to protect it against competition (try building a new railroad).
Although Union Pacific is based in Buffett's home town of Omaha, in 2009 his company Berkshire Hathaway bought its main competitor, the Fort Worth-based Burlington Northern Santa Fe Railway.
The numbers
My preferred measure for earnings per share (eps), diluted eps, which assumes all outstanding share options are exercised, rose last year by 48% to $5.53. Union Pacific's current share price of $94.51 puts its shares on a price-earnings ratio of 17.1, whilst the dividend of $1.52 per share represents a yield of 1.6%.
Allowing for the 2-for-1 share split in 2008, Union Pacific's diluted eps for 2005 was $1.92. So earnings have grown by 23.6% per year since then, an excellent performance which puts the shares on a five-year historic price-earnings to growth ratio (PEG) of just 0.73 (a PEG ratio of less than 1 is generally considered to be cheap).
Admittedly, if you go further back the figures aren't quite so good. Eps in 2001 was almost the same as in 2005, so the compound earnings growth since 2001 is 12.5% per annum.
The future
When you buy a share you aren't getting its past returns, you're buying a stake in its future prospects. I'd argue that Union Pacific will continue growing strongly because high oil prices are here to stay, favouring rail over road.
Furthermore, if environmental regulations are passed to limit carbon monoxide and carbon dioxide emissions, the railways will benefit because it takes far less fuel to move a ton of freight by train than by truck.
Trains are far more environmentally friendly than trucks and railroad shareholders should profit from this. Investors should note that businesses often profit from regulations, especially when they are designed to increase their competitors' costs!
The risks
As the last few years have demonstrated, the railways are highly geared to the performance of the American economy, so when this falters so will Union Pacific.
There is a chance that Congress will over-regulate the railroads because they have become too profitable, but every business takes the risk that politicians will meddle in their affairs. Success breeds envy and jealousy, although far less so in America than in Britain.
Furthermore, the proposed high-speed passenger rail service would use some of the existing tracks, reducing the number of freight trains that could be run every day.
In my book, Union Pacific and Burlington Northern Santa Fe are the pick of the bunch because they serve the west coast ports. It is through these ports that America will keep on shipping raw materials to the Asia-Pacific rim whilst bringing in imports -- the west coast rails will get a lot of business from this.
More from Tony Luckett:
> Tony owns shares in Berkshire Hathaway and Union Pacific Corporation. His favourite western is The Adventures of Brisco County Jr. (that explains a lot -- Ed)
