As U.S. markets continue to reel, there are few sectors and companies that provide safe passage. But U.S. railway companies are filling that void as they steam ahead.

There are very specific reasons for the success of the four major U.S. railway companies. First, high oil prices have made them more competitive than trucking companies, allowing them to impose surcharges to cover most of the rising cost of fuel. Second, even though they trail Montreal-based Canadian National Railway Co. in terms of efficiency, the four firms — Fort Worth, Tex.-based Burlington Northern Santa Fe Corp. ; Jacksonville, Fla.-based CSX Corp.; Norfolk, Va.-based Norfolk Southern Corp.; and Omaha, Neb.-based Union Pacific Corp. — are efficient, well run and offer good quality in both service to customers and return on capital to investors.

In fact, you can’t go wrong by investing in U.S. railways, says Dan Bastasic, manager of Mackenzie Financial Corp. ’s Mackenzie Universal Infrastructure Fund in Toronto. He is typically invested in four or five firms, and picks the ones that are most profitable and have the strongest cash flow.

Bastasic likes BNSF in particular, as does famed investor Warren Buffett, chairman and CEO of Omaha-based Berkshire Hathaway Inc. Buffett, too, is invested in railway companies; in fact, Berkshire owns 17% of BNSF’s shares.

There are two big reasons why BNSF has gained favour with investors. First, future energy needs in the U.S. will be met, in part, by clean coal from the Powder River Basin on the Montana/Wyoming border; BNSF serves this area. In addition, the company is a major carrier of intermodal containers, which can be moved from ships to railways to trucks, and are being used increasingly for transporting consumer goods.

None of the four major railways span the entire nation, however. CSX and Norfolk cover the eastern third of the country, west to Chicago and New Orleans — essentially, east of the Mississippi River. In contrast, BNSF and Union Pacific operate west of the Mississippi. (Only CN provides service to all three coasts of North America.)

BNSF and Union Pacific are the bigger among the U.S. majors, each generating revenue of $8.7 billion-$8.8 billion in the six months ended June 30. (All figures are in U.S. dollars.) By contrast, CSX and Norfolk each had revenue in the range of $5.3 billion to $5.6 billion for the same period. Norfolk, however, is the most efficient of the four, with an operating margin of 73.8% vs CSX’s 76.1%, Union Pacific’s 80.5% and BNSF’s 81.8%.

Of the products that these railways transport, coal accounts for more than 20% of revenue for BNSF and Union Pacific, and almost 30% for CSX and Norfolk. Like BNSF, Union Pacific’s rail lines access the Powder River Basin. BNSF and Union Pacific also service the U.S. Midwest grain belt, with agricultural products accounting for almost 20% of their revenue.

There are analysts who recommend each of these companies’ stocks; few analysts, if any, suggest selling them. Here’s a look at the four firms in more detail:

> Burlington Northern Santa Fe Corp. In addition to Buffett and Bastasic, Dan Ortwerth, a transportation analyst with Edward Jones in St. Louis, Mo., likes BNSF, noting that its return on invested capital has been moving upward slowly but steadily, thanks to the strength of its management team, its access to the Powder River Basin and its strong presence in intermodal transport. The company has a strong safety record.

Ortwerth says that coal from the Powder River Basin is not only the cleanest in the U.S. but also the cheapest, as it’s near the surface and easy to extract. Coal, including that from the Powder River Basin, generates about 50% of U.S. electricity; Ortwerth expects this to increase. He notes that there is steady improvement in coal-cleaning methods and expects evidence will show that coal can be used in ways consistent with social and environmental values. BNSF is expanding the number of destinations to which it transports coal.

BNSF has the largest presence of the four railways in intermodal transport, adds Ortwerth: BNSF can put 100 to 200 containers on a train; it has a key line linking Los Angeles and Chicago; and it has invested heavily in increased “throughput,” which is the volume of traffic that can be conveyed through a route.

@page_break@STOCK IS EXPENSIVE

However, other analysts are less enthusiastic about BNSF, including Charles Burbeck, head of global equities with HSBC Halbis Partners in London. He admits BNSF is a very well-managed firm with good growth prospects. And he finds Buffett’s enthusiasm for the company a plus. But he believes BNSF’s stock is expensive, particularly if the U.S. slowdown/recession is protracted, as some analysts think is likely.

As well, a report issued by New York-based UBS Securities LLC raises concerns about the amount of intermodal units that BNSF carries; these containers carry mainly consumer products, and demand for consumer products is currently weak in the U.S. Intermodal transport accounted for 21% of BNSF’s $8.5 billion in freight revenue in the six months to June 30, the largest exposure among the four U.S. majors. The UBS report rates the stock “neutral,” even though its 12-month share price target of $114 is well above the $101.58 at which the stock closed on Sept. 12.

Reports from two other New York-based firms, J.P. Morgan Securities Inc. and Argus Research Co., also rate the stock “neutral.” The Argus report says BNSF’s prospects are built into its share price, while the J.P. Morgan report says the stock isn’t expected to move up significantly until intermodal transport returns to growth mode — which would probably move share prices higher, assuming there isn’t a sharp pullback in fuel prices.

BNSF reported net income of $805 million in the six-month period, up from $782 million in the same period a year prior. Revenue was $8.7 billion in the first half of 2008 vs $7.5 billion a year earlier. The operating ratio was 81.8% vs 79.5%. Operating cash flow after net change in non-cash working balances was $1.7 billion vs $1.6 billion, and long-term debt was $8.4 billion as of June 30. There are 344.4 million widely held shares outstanding.

> CSX Corp. Both the UBS and Argus reports prefer CSX to BNSF — although, in Argus’s case, only if the stock is going to be held for five years; the report rates the stock as “neutral” for the next 12 months.

The UBS report has a 12-month target price of $76 a share, vs the $61.61 at which the shares closed on Sept. 12. This is based on “positive mix effects as high-margin freight grows and low-margin freight declines.”

CSX reported $5.6 billion in freight revenue in the six months, with coal generating 28% of that — a 24.8% improvement from the same period a year ago. Intermodal transport and chemicals — phosphates and fertilizers — each accounted for 13% of revenue, with the latter 22.9% higher than for the same period in 2007. Agricultural products represented 9% of revenue, 30% higher. Only revenue from automobiles, at 7% of total revenue, and forest products, at 6%, were down — by 4.5% and 2.4%, respectively.

The UBS report expects productivity gains, which have stalled, to rebound in the fourth quarter. The report also points out that floods in the U.S. Midwest in late June/early July affected CSX’s operating ratio. “CSX will need to see operations bounce back,” the report says, “and start posting year-over-year improvements in order to have the conviction that CSX can hit its low-70s operating ratio target by 2010.”

The Argus report argues that, given the precarious state of the U.S. economy, any earnings surprises are likely to be on the downside. It does say, though, that if CSX’s stock price falls back around $50 and/or if the shift to railways from trucks accelerates, Argus analysts would consider upgrading the 12-month recommendation to a “buy.”

The J.P. Morgan report is more cautious, rating the stock as “neutral” — although, it says, CSX’s sensitivity to further slowing in the U.S. economy is limited, given the strength of coal and agriculture.

CSX shareholders voted to the board four directors backed by hedge funds, which own 8.6% of the railway’s 407.6 million widely held shares. The hedge funds have been pressuring CSX to improve its performance. CSX is contesting the right of these hedge funds to vote their shares, based on their failure to disclose the full amount of their holdings. The Argus report suggests this appeal is unlikely to succeed.

GROWING PROFITS

CSX reported net income of $736 million in the six months, up from $564 million in the same period in 2007. Revenue was $5.6 billion vs $5 billion a year earlier. The operating ratio was 76.1% vs 77.8%. Operating cash flow after net change in Non-cash working balances was $1.3 billion vs $1.1 billion. Long-term debt was $7.4 billion as of June 30.

> Norfolk Southern Corp. Mark Chaput, assistant vice president and portfolio manager with I.G. Investment Management Ltd. in Montreal, favours Norfolk because it is the most efficient of the four major U.S. railway firms.

As such, Chaput feels that Norfolk’s stock is undervalued because investors are playing “momentum stories” that favour CSX and Union Pacific. He admits that Norfolk needs a better economy, but he is willing to wait. He also notes its strong balance sheet and cash-flow generation, and likes the fact that the management team is focused on returning cash to shareholders, as witnessed by a 32% increase in its dividend during the past five years.

The J.P. Morgan report suggests “overweighting” Norfolk stock because it sees “meaningful upside” for the company. The report doesn’t provide a 12-month price target, but suggests the price will rise to 15 times earnings, the average for the other three major U.S. railways, from 14.1 times earnings — although the report says this may take time. This suggests a price of $73-$74 a share, vs the $67.97 at which the 375.2 million widely held shares closed on Sept. 12.

The Argus report suggests that around $70 would be a fair price for the stock and rates it a “hold.”

The UBS report rates the stock as “neutral,” even though it has a high 12-month target price of $76 a share. The report says that “re-accelerating pricing was a pleasant surprise in the second quarter” and states the belief that there’s probably more to come.

In the six months ended June 30, coal accounted for 27.3% of Norfolk’s $5.3 billion in freight revenue; intermodal transport, 19.3%; metals and construction, 12.5%; chemicals, 11.9%; and automo-biles, 8.6%.

Norfolk reported net income of $744 million in the six months, up from $679 million during the same period a year earlier. Revenue was $5.3 billion vs $4.6 billion. Norfolk’s operating ratio was 73.8% vs 79.9% and its operating cash flows, after the net change in non-cash working balances, was $1.06 billion vs $1.14 billion. Long-term debt was $6 billion as of June 30.

> Union Pacific Corp. The UBS and J.P. Morgan reports both suggest buying or overweighting this stock. The UBS report calls Union Pacific “the best long-term margin story.” It expects earnings per share to double by 2012 and has a 12-month price target of $100 a share, well above the $77.80 at which the 552.8 million widely held shares closed on Sept. 12.

“We don’t care about volumes and view Union Pacific exclusively as a productivity and pricing story,” says a July 24 UBS report. “If volumes come back in the near term, wonderful. But we’re not forecasting it and we don’t think we need it for the stock to continue to work.”

Another UBS report issued on Aug. 28 notes that 20% of Union Pacific’s revenue is under legacy contracts that will be repriced upward over the next few years.

The J.P. Morgan report, likewise, says the company has the “most robust earnings growth story of the major railroad firms over the next several years, driven by productivity/cost-side improvement in 2008-09 and revenue tailwind from its legacy contract repricing story, which will last through 2011.”

The report adds that Union Pacific has limited sensitivity to weakness in the U.S. economy.

Energy, mainly coal, accounted for 21.1% of Union Pacific’s $8.4 billion in freight revenue in the six months. Agricultural products accounted for 18.2%; intermodal transport, 17.6%; and chemicals, 15%.

Union Pacific reported net income of $974 million in the six months, up from $832 million in the same period in 2007. Revenue was $8.8 billion vs $7.9 billion. The operating ratio was 80.5% vs 80.9%. Operating cash flow, after net change in Non-cash working balances, was $1.8 billion vs $1.5 billion. Long-term debt was $8.2 billion as of June 30. IE