Genesee & Wyoming (NYSE:GWR) is certainly not a regular rail story. Unlike Class 1 railroads like Union Pacific (NYSE:UNP) or Norfolk Southern (NYSE:NSC), acquisitions are a significant part of the growth story and foreign operations are key to the company's future. Also, unlike many rails, investors are willing to pay a pretty hefty multiple to own this railroad.
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A Mixed End to 2011
Genesee & Wyoming's earnings for the fourth quarter were relatively mixed. Revenue was pretty good, as reported revenue rose 24% and "same rail" revenue climbed 8%. Although carload volume was modest, yield was up nicely.
Profitability was less impressive, though. Due in part to some operating challenges that included outages and capacity issues, the operating ratio (on an adjusted basis) fell about half a point to 78.6%. That's not great compared to what other Class 1s like Union Pacific or CSX (NYSE:CSX) produced this quarter, but it's not a terrible result either. That said, a lower than expected tax rate helped the reported result and actual underlying earnings were soft relative to expectations. (For related reading, see A Primer On The Railroad Sector.)
Challenges Will Pressure the First Half of 2012
Genesee & Wyoming isn't going to have smooth sailing ... er, "railing" ... for the first half of 2012. The company will be recovering from a derailment and will also be seeing less coal demand from a few utilities. Later in the year, though, commodity traffic in Australia should start to pick up meaningfully and this rail should also see some benefit from its relatively larger exposure to industrial products.
Australia is a Growth Opportunity
For all intents and purposes, Genesee & Wyoming is very nearly a Class 1 operator in Australia, and it's well-positioned relative to up and coming mineral projects. GWR already has a significant relationship with OneSteel (a large Australian steel company) and its tracks lay close to potential projects under development by Rio Tinto (NYSE:RIO) and BHP Billiton (NYSE:BHP).
With Asian demand for commodities likely to heat up again, GWR could see growing demand for its rails to transport iron, copper and other commodities, to key ports like Darwin. Operating ratios are already looking pretty strong in Australia and increased traffic is likely to produce outsized gains in profitability.
It's also worth mentioning that the company's acquisition of AZER in 2011 brings Freeport McMoRan (NYSE:FCX) into the fold as a customer.
Should Investors Pay This Much for the Differences?
Valuing Genesee & Wyoming is tricky. Unlike the Class 1 operators, there is still a lot of room for the company to grow through acquisition; more than half of the short lines out there are still owned by small companies and potential buyout targets. There's also an above-average organic growth kick here as well, not only from increased mineral shipments in Australia, but also a recovery in construction in the U.S.
Unfortunately, it's hard to find a way in which this stock is cheap. Above-average growth and operating leverage are certainly worth premiums, but it looks like the Street is already tuned in that the potential. Strong traffic growth could continue to support the valuation, but investors should realize that an already-high valuation could make this stock more volatile than average.
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At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.