The QR National Float – Barefoot Bluechips

Should you buy some shares in the QR National float?

Well, if you were to ask the four men who’ve had the greatest influence of my life, they’d all say ‘yes’.

Both my grandfathers got their gold watches from a lifetime on the railways, and, while my father never followed the same career path, he’s certainly a train tragic.

For his sixtieth birthday we got him a voucher to take a steam train-driving lesson. One hand was on the rudder (or whatever you call it) and his other was on a shaky handicam – the results of which get dragged out each time I visit him (including recently, when I took my girlfriend home for the first time).

Then there’s my other great mentor, Warren Buffett, who likes rail so much that last year he made his biggest ever acquisition, $US34 billion, to buy the second biggest rail operator in the US, Burlington Northern Santa Fe.

This all sounds positive, so let’s see if QR National is a Barefoot Bluechip you should buy.

How do they make their dough?

QR National is Australia’s largest rail freight company.

Their fleet of more than 700 locomotives and 16,000 wagons primarily transports coal and iron ore from inland Queensland mines to the ports, where it’s then shipped to Asia.

While QR National has 2,300 km of dedicated track in Queensland, it has a national footprint, last year hauling 260 million tonnes across the country – which is where the tagline ‘Be Part of Something Big’ comes from.

The billions of Chinese and Indians rapidly moving from poverty to middle class is the investment story of our lifetime. The opportunity to invest in a business that hitches its wagon to this (bad pun intended) is an attractive proposition. History tells us that in a boom it’s not just the miners who make a fortune, but the suppliers as well – just ask Levi Strauss.

Tell me the good stuff

The Queensland Treasurer, Andrew Fraser, summed up the company’s potential at a recent press conference: “This is a once-in-a-lifetime opportunity. There is no other opportunity out there to leverage into the Asian region . . . and the resources boom. It is a unique proposition.”

Then again, he would say that. He is after all in charge of selling the company, and stands to replenish his state’s (debt-laden) coffers to the tune of $5 billion.

There are three reasons to invest in QR National:

1. As China’s demand for coal and iron ore increases, the increased cost of hitching another wagon behind a locomotive is marginal – Fraser was right, this is a leveraged play on China.

2. Free from government ownership, QR National will (eventually) be able to cut both jobs and unprofitable routes, making the company much more efficient and therefore more profitable.

3. The Government doesn’t want to do the dirty on the public, which is why they’re leaving a bit on the table for (voting) shareholders. The last thing it wants is to sell the public a company they already own and have them lose money on it from day one. Anna Bligh may be unpopular, but she’s not stupid.

That’s why the Government has come up with a number of bribes to stop the shares tanking too soon: retail investors get a 10-cents-per-share discount to the institutions, and investors get a ‘loyalty bonus’ of one share for every 20 they hold until 7 December 2011.  (Queensland investors fare even better: one bonus share for every 15.)

Tell me the bad stuff

The Government has resorted to playing short-term tricks like loyalty bonuses to get the float away.

There are also a number of legislative risks, notably the introduction of the mining tax and the threat of a carbon tax decreasing the demand for coal. And don’t forget the miners, who could take their super profits and plough it into freighting the goods themselves. Yet these are all risks that are marginal at best. It’ll take China’s economy imploding (or at the very least softening) to derail this train.

Yet one thing that may cause a derailment is the company’s $3 billion loan facility. Railroads are a capital-intensive business – tracks, carriages, etc – which is why the Government is selling it off. The prospectus shows the company has committed to a $3.75 billion capital spending program by the end of 2012, of which $2.4 billion will be borrowed.

The prospectus argues that much of this spending is for profitable expansions, but the rapid increase of debt puts the screws on things (just ask rail operator Asciano – QR National’s biggest competitor – whose share price has been whacked because of bloated debts and poor performance).

And while no-one can predict what the share price will do, we can predict the income (‘dividend yield’) we’ll get each year from the company. And it’s a measly 2.5 to 3 per cent – and they’re borrowing money to pay it!

Toes up or toes down?

“I think I can, I think I can” said the Little Red Caboose – at Labor Party headquarters in Brisbane.

To give it a little push up the hill, they’ve shelled out nearly $35 million to banks, brokers and various consultants, and carpet-bombed the media with $15 million of advertising.

Yet the great thing about being investors is that we can bypass the loyalty bonus share bribes and take our time. This train’s at the beginning of a long and hopefully profitable journey, with many stations to stop at.

Taking a leaf out of Warren Buffett’s book, you’d be wise to wait and see what happens to the company when the Government has sold off its remaining 35-40 per cent stake (scheduled for sometime after 2012), and to see how the company performs under the weight of nearly $3 billion in debts.

I’ll be keeping my train fare in my pocket for a couple of years.

Tread your own path!