Class I Freight Railway

A Class I freight railway is the premier league of railroads in North America. This official designation, granted by the U.S. Surface Transportation Board (STB), is reserved for the largest freight railroad companies based on their annual operating revenue. To join this exclusive club, a railroad must meet a specific revenue threshold, which was set at $900 million in 2022 and is adjusted periodically for inflation. These aren't just big companies; they are the steel arteries of the continent's economy. They haul everything from the grain in your cereal and the car in your driveway to the coal that powers your city and the packages arriving at your door. For an investor, understanding Class I railroads means looking at businesses with immense scale, strategic importance, and powerful, long-lasting competitive advantages. They are, in many ways, a physical manifestation of the economy itself, making them a fascinating subject for any student of value investing.

The landscape of Class I railroads is a small and exclusive one, a classic oligopoly that dominates North American freight. As of the early 2020s, this elite group consists of:

• BNSF Railway (owned by Berkshire Hathaway)
• Union Pacific Railroad
• CSX Transportation
• Norfolk Southern Railway
• Canadian National Railway
• Canadian Pacific Kansas City (formed from the 2023 merger of Canadian Pacific and Kansas City Southern)

These giants effectively create regional duopolies. In the western U.S., shippers largely choose between BNSF and Union Pacific. In the east, it's a face-off between CSX and Norfolk Southern. The two Canadian players run extensive networks across Canada and deep into the U.S., connecting all three North American countries.

Legendary investors like Warren Buffett have famously invested heavily in railroads. The attraction lies in their powerful and durable business characteristics, which are music to a value investor's ears.

The core appeal of Class I railroads is their massive economic moat—a nearly insurmountable competitive advantage that protects their long-term profits.

• Irreplaceable Assets: Imagine trying to build a new 30,000-mile railroad network across the United States today. The cost of acquiring the land, navigating environmental regulations, and laying the track would be astronomical, if not impossible. This creates an incredibly high barrier to entry that keeps new competitors out.
• Pricing Power: Because shippers in many regions only have one or two railroad options for moving heavy, bulk goods, the railroads command significant pricing power. They can raise prices consistently, often at or above the rate of inflation, without losing much business.

Railroads are a model of efficiency and scale, a crucial advantage in the business of moving heavy things.

• Cost Advantage: For moving bulk commodities like coal, grain, chemicals, and automotive parts over long distances, nothing beats rail. A single train can haul the cargo of hundreds of trucks using far less fuel per ton-mile. This inherent efficiency makes them the go-to choice for the building blocks of the industrial economy.
• Focus on Efficiency: Investors should get to know a key metric: the operating ratio. This is calculated as a company's operating expenses divided by its revenue (Operating Expenses / Revenue), with a lower percentage indicating better profitability and efficiency. Over the past two decades, Class I railroads have relentlessly focused on lowering this ratio through a strategy called Precision Scheduled Railroading (PSR). PSR is an operational model that aims to move railcars on a fixed schedule, much like a passenger airline, to maximize asset utilization, reduce costs, and improve service reliability.

While the moats are wide, investing in railroads is not a one-way ticket to riches. Investors must be aware of the inherent risks.

• Economic Sensitivity: Railroads are a deeply cyclical business. Their volumes are directly tied to the health of the industrial economy. When a recession hits and manufacturing slows, demand for freight transport plummets, directly impacting revenues and profits.
• Regulatory Oversight: As natural monopolies in many areas, railroads are under the watchful eye of regulators like the STB. If service quality falters or pricing is deemed excessive, regulators can step in, potentially limiting their ability to set rates or approving mergers.
• Capital Intensity: Running a railroad is an expensive endeavor. Maintaining and upgrading thousands of miles of track, bridges, tunnels, locomotives, and railcars requires massive and continuous capital expenditures (CapEx). These high costs can eat into cash flow, especially during economic downturns.