Tracking Inflation and Riding the Rails

10/14/2013 10:00 am EST

Focus: INDUSTRIALS

Benjamin Shepherd

Analyst, Breakthrough Tech Profits, Global Income Edge and Personal Finance

Worried about future inflation? Ben Shepherd's new advisory, Inflation Survival Letter, is designed to protect portfolios against the risks of inflation; he highlights one favorite inflation-resistant stock, a leading railroad operator.

Steve Halpern: We're here today with Ben Shepherd, editor of the Inflation Survival Letter. How are you doing today, Ben?

Ben Shepherd: Terrific, Steve, how are you?

Steve Halpern: Good. Could you tell our listeners a little about your newsletter and an overview of your investing strategy?

Ben Shepherd: Sure. I've been concerned about the prospect of inflation, really ever since the US Federal Reserve implemented its zero interest rate policy and began aggressively pursuing a program of quantitative easing.

I believe one of government's greatest functions is to, kind of, smooth out the economic bumps in the road, but unfortunately, it has an extremely poor track record of timing its actions to do the most good, while doing the least harm.

Former fed chairman Alan Greenspan admitted that the steps that he took to pull the United States out of the recession in the early 2000s played a direct contributory role to the real estate crisis that brought the global financial system to it's knees in 2008.

So really, my investing strategy is all about finding those assets and those companies that, not only can weather an inflationary bubble that I feel is most likely inevitable given the fed's generally poor timing, but can also profit and benefit us in the meantime.

Steve Halpern: You look at inflation on both a short-term and long-term basis, and right now inflation does not appear to be a near-term problem, so I'm assuming you're talking about the long-term possibilities of a rise in inflation.

Ben Shepherd: The long-term possibility is definitely one of my chief concerns, but at the same time, I would argue that inflation today is much, much worse than what the government is telling us.

The official consumer price index right now says that inflation is running at less than 2%, but the average consumer's day-to-day experience tells you that it's actually a lot higher than that, probably closer to the 8 or 9% range. The price of foodstuffs have gone up, rents are going up, even as incomes are largely stagnating.

It's just getting harder and harder to stretch a dollar, and right now, I would say that we're in a pre-inflationary stage, where it's true that it's not as big of a concern as it could be. But I see the problem getting much worse as we go forward, particularly three years out when the fed has reached a point where it really has no choice but to start backing-off its quantitative easing, because it's getting uncomfortable with its own measurement of inflation.

By that point, the damage is already done, the ball is already rolling, and it's going to take the fed an extended period of time to bring those price increases back under control, so really, right now is when I would say investors should be positioning themselves to not only hedge, but to also profit from the coming inflation.

Steve Halpern: Now, in terms of that kind of positioning, your research coverage includes what you call inflation protection securities. What are these and how can investors use these types of securities to protect themselves from the concern of future inflation?

Ben Shepherd: Well, inflation protected securities is really just what the name implies. They're investments in companies that have, say, a virtual monopoly in their market, so they have strong pricing power to be able to pass through the impact of inflation and recoup those costs.

There are certain types of bonds available in the market, such as leveraged loans or bank loans, where the coupons reset on a periodic basis, so the interest on the loan rises along with inflation and interest rates.

Real estate has historically been a solid inflation hedge, assuming you're investing in the right types of real estate, so by going ahead and adding those types of assets into their portfolio mix, investors can realize strong returns in the here and now, as both the US and the global economy continue this slow but steady pace of recovery, as well as realize even better profits down the road as inflation heats up.

Steve Halpern: A recent addition to your model portfolio is rail operator Norfolk Southern (NSC), which you call a terrific inflation hedge. Can you expand on that and explain why you've added that stock to your portfolio?

Ben Shepherd: Well, Norfolk Southern is the very definition of a natural monopoly. Over the past century, it's been building a rail network that literally spans the eastern seaboard and reaches as far inland as Kansas City.

It's impossible for a competitor to come in and duplicate those assets, simply because of the prohibitive amount of capital expenditure that would be necessary to do that, so Norfolk Southern has extremely strong pricing power.

And in an inflationary environment, fuel prices tend to rise, as we saw in the 2006-2007 period when inflation was picking up, Norfolk Southern was able to recoup a lot of that cost through fuel surcharges, and as their operating expenses rise generally, since shippers really don't have much of a choice on the east coast but to go with Norfolk Southern, they're able to pass through those price increases.

Right now I would say that Norfolk Southern is actually undervalued though. It has a large presence in Appalachian coal country, and one thing that we've seen over the past couple of years is coal demand has been slipping, largely as the Obama administration has implemented new regulations on coal burning utilities, in the forms of tighter emission caps and things of that nature, but Norfolk Southern is actually much more diversified than just coal.

They have a large intermodal business, which is basically the capability to take shipping containers off of ships, load them onto trucks, which take them to a rail hub, where they're loaded onto a train, taken on to their final destination, loaded back on a truck, and taken to the ultimate end user.

Norfolk Southern has been experiencing strong growth volumes in that intermodal traffic, as that's become the preferred shipping method for, really, any bulk shipper. They're also benefiting from growing commodity transports.

One of the things that we've seen, as a result of the fracking revolution, are just surging natural gas inventories, but right now, there's not the pipeline infrastructure to move a lot of that oil and gas from the areas where it's being produced to the end market.

It's going to take several years for that pipeline infrastructure to catch up, and in the meantime, a lot of those commodities are being moved via rail tanker cars, and Norfolk Southern is picking up a lot of that traffic as well.

Despite this low, sort of, market sentiment about the railroads, earnings have remained relatively steady. Norfolk Southern just recently increased its dividend, I believe, for the 22nd consecutive year, and is generally just one of the most efficiently run railroads in the United States, largely because a lot of its traffic moves down out of the Appalachian Mountains.

So it's able to use its fuel much more efficiently, it's implemented computer control systems, that not only reduce the risk of accidents, but also reduces congestion on the network as a whole, so given that level of efficiency, strong earnings, the protection provided by its natural monopoly, and its growing dividend, I really think Norfolk Southern is a solid buy right now.

Steve Halpern: Well, we really appreciate you taking the time today. Thanks for joining us.

Ben Shepherd: Thank you, Steve, I appreciate the opportunity.

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