The investment case for listed railroads

Railroads play a critical role in facilitating the efficient movement of goods and essential commodities in North America.

Over the last thirty years, railroads have evolved from heavily regulated businesses with returns at or below their cost of capital into lightly regulated and capital-efficient networks distinguished by infrastructure that is difficult to replicate.

This article discusses the investment merits of listed railroads and examines the industry's recent history to contextualize how the recent industry dynamics will impact future growth.

Investment merits of listed railroads

Several characteristics make Class I railroads—the largest freight carriers in North America, as defined by the Surface Transportation Board (STB)—an attractive allocation within global listed infrastructure portfolios.

Railroads’ sustainable advantages are threefold:

1. Irreplaceable infrastructure
2. Limited competition between railroads
3. Pricing power

Irreplaceable infrastructure

Railroads own their networks, which include miles of track, bridges, tunnels, and thousands of locomotives. The replacement value of these networks is well in excess of the market capitalization of their stocks. Annual maintenance expenditures typically equal 16 billion U.S. dollar per year, or 16% of a railroad’s revenue. Such elevated capital requirements create high barriers to entry and ensure that railroads will remain essential to a well‑functioning supply chain decades from now.

Limited competition among railroads

Decades of consolidation between Class I railroads created local monopolies and oligopolies across North America. Industrial customers and commodities producers make up 80% of rail freight revenue, on average, and are generally served by a single railroad. It is uneconomical for a competitor to target the customers of a nearby railroad due to the prohibitive costs of building new track capacity and the cost advantage held by incumbent railroads.

There is more competition, however, for intermodal transport (shipments that combine multiple modes of transportation, such as rail and truck), which accounts for the remaining 20% of North American rail freight business. Trucks compete with railroads on price and service for domestic intermodal freight, while railroads compete with each other on service for international intermodal routes. Large intermodal ports, such as those in Los Angeles and Long Beach, are served by more than one railroad.

Pricing power

The combination of irreplaceable infrastructure and limited competition leads to pricing power for the railroads. This is evident in operating margins, which are close to 40% on average, and return on invested capital (ROIC), which averaged roughly 11% across multiple freight cycles over the last two decades (Figure 1).

Risk and opportunities of investing in railroads

Railroads have delivered attractive returns to shareholders for a long time. Over the last 10 years, the average annual return of Class I railroad stocks has been ~13% compared to ~11% for the MSCI World Index, through December 31, 2025.

However, railroad stocks can sometimes be more volatile than the average listed infrastructure stock, due to exposure to freight market cycles and the lightly regulated nature of their business models.

The good news is that selloffs have historically been short‑lived, because it takes a significant freight recession for the earnings of a railroad to decline. Since 2000, there have been only two instances in which railroad stocks posted average annual declines greater than 25%—the 2008 financial crisis and the 2015 industrial mini-recession (Figure 2).

Sector drawdowns have historically created attractive buying opportunities, so we view liquidity as one of the benefits of investing in listed railroads. Additionally, allocating capital to railroads in the private markets is difficult because access is limited. Only the regional short-line operators are available in private markets, and they are significantly smaller in size than the Class I operators.

Understanding how these advantages emerged is important. The next section traces the industry’s evolution since 1980 across three phases and details how each phase reinforced today’s investment case.

Historical evolution of the U.S. railway industry from 1980 to today

Over the past four decades, the U.S. rail industry transitioned from a period of extensive regulation and financial challenges to a capital‑efficient model with durable competitive advantages.

The journey unfolds in three phases:

1. Deregulation and consolidation (1980 to 2001)
2. The “rail renaissance,” (2001 to 2021)
3. More balanced growth and the return of mergers & acquisitions (2022 to today)

Deregulation and Consolidation (1980 to 2001)

The first phase of modern rail history was marked by deregulation and consolidation. By 1980, decades of restrictive oversight had left railroads financially distressed and unable to maintain their networks. This culminated in the Staggers Rail Act of 1980, which deregulated the industry allowing market-driven pricing, and the ability to shed unprofitable routes.

The sweeping regulatory overhaul also led to an unprecedented wave of M&A. The number of Class I railroads were reduced from forty in 1980 to just seven by 2000. Those remaining included the Burlington Northern Santa Fe, Canadian National (CNI), Canadian Pacific (CP), CSX Transportation (CSX), Norfolk Southern (NSC), Union Pacific (UNP), and Kansas City Southern.

Consolidation and deregulation improved the financial health of the industry and railroads could finally reinvest in infrastructure, improve safety, and offer better service.

Rail renaissance (2001 to 2021)

In 2001, the federal agency that oversees railroads, the STB, imposed stricter merger rules, requiring any consolidation to be pro-competition and in the public interest. This effectively halted large-scale mergers and shifted the industry’s focus to organic growth.

Building on the stronger competitive positioning achieved through consolidation, railroads began to exercise their pricing power by repricing legacy contracts above inflation and implementing precision scheduled railroading (PSR), an operating model that focused on maximizing locomotive and labor productivity, and improving asset utilization. The results were transformative: operating margins improved from roughly 20% in the early 2000s to 40% by 2021. (Figure 3).

This margin expansion drove average annual earnings-per-share (EPS) growth of approximately 15% despite limited revenue growth. From 2001 through 2020, rail stocks outperformed the broader global equity market in all but two years.

More balanced growth and the return of M&A (2022 to today)

The most recent period of railroad evolution started with a partial reversal of the profitability improvements achieved during the rail renaissance.

Railroads faced operational challenges during the COVID-19 pandemic. A significant increase in port congestion in 2021 led to deteriorating service metrics. Rail companies had to increase headcount to restore adequate service metrics at a time when volumes were under pressure from a weakening freight market. These headwinds, combined with rising costs, led to a decline in operating profitability, which translated into muted EPS growth for most rails (Figure 4). As a result, the stocks delivered poor returns compared to the broader equity markets.

Today, service metrics have vastly improved and networks are more than adequately resourced. We believe the railroads are now positioned to regain the margins lost over the last 3-4 years and return to solid earnings growth but with a more balanced mix of margin expansion and revenue growth.

The industry also started to look at M&A once again as an avenue for growth given the lower runway for margin expansion today compared to a decade ago. In December 2021, Canadian Pacific’s (CP) closed the acquisition of Kansas City Southern (KSU) and created a single-line network from Canada to Mexico, positioning the company to capitalize on the secular growth in cross-border trade.

More recently, Union Pacific (UNP) has proposed to acquire Norfolk Southern (NSC). If authorized, the transaction would facilitate a direct single-line service connecting the East and West Coasts of the United States. The combined network would deliver significant cost savings to customers via faster transit times for intermodal freight and benefits to shareholders as well via faster growth relative to UNP as a standalone rail. The STB’s pending decision on the UNP/NSC merger, expected in early 2027, could redefine competitive dynamics and create a new platform for long-term EPS growth.

Concluding thoughts

We believe listed railroads are quality businesses that should play an integral part of any listed infrastructure portfolio.

The stocks have historically delivered solid returns but the performance has been disappointing over the last three years due to operational challenges. With these issues largely behind them, we believe the railroads are well positioned for solid earnings growth and to deliver long-term value for investors.