The Zacks Transportation - Rail industry is being aided by a steady improvement in freight demand, thanks to the buoyant U.S. economy, which is driving growth for the railroads. Despite this tailwind, the industry is being plagued by escalating fuel prices and supply-chain disruptions.
Companies like Union Pacific Corporation UNP, Canadian Pacific Railway Limited CP, CSX Corporation CSX and Norfolk Southern Corporation NSC are expected to thrive on upbeat freight demand.
About the Industry
The Zacks Transportation - Rail industry consists of railroad operators transporting freight (such as agricultural products, industrial products, coal, intermodal, automotive, consumer products, metals and minerals), primarily across North America. These companies focus on providing logistics and supply-chain expertise services. While freight constitutes a significant chunk of revenues, some of these companies also derive a small portion of their top line from other rail-related services, including third-party railcar and locomotive repairs, routine land sales and container sales, among others. A few companies offer service to multiple production and distribution facilities. Besides owning locomotives, some of these companies have equipment of leased locomotives, railcars etc.
4 Trends Shaping the Future of the Railroad Industry
Healthy Freight Demand: Freight demand continues to be strong in 2022 as pandemic fears fade, despite softening from the 2021 levels due to a shift in consumer spending from goods to services. The Cass Freight Index rose 2.9% on a year-over-year basis in October. With steady freight demand, railroads are benefiting from higher volumes and pricing gains. The upbeat freight environment is expected to continue in the near term.
Dividend Hikes Signal Financial Strength: With the resumption of economic activities, many players, including some railroad companies are reactivating their shareholder-friendly measures like paying out dividends, which underline their solid financial footing and confidence in the business. Earlier in 2022, both UNP & CSX upped its dividend 10% and 7.5% to $1.30 per share and 10 cents per share, respectively.
Supply-Chain Disruptions a Woe: Persistent supply-chain disruptions, including labor and equipment shortages, are hurting railroad volumes in some segments, especially the carload and intermodal unit. Per The Association of American Railroads’ latest rail traffic data, the total U.S. carload and intermodal units declined 0.5% year over year in October 2022. Supply-chain disruptions are likely to persist for a while now, thus denting carload and intermodal volumes.
High Fuel Costs Hurt Bottom Line: Operating expenses are on the rise, mainly due to increased fuel costs. Fuel expenses represent a key input cost for any transportation player. High oil price (up 5.7% in the first nine months of 2022) is augmenting fuel costs. Even though oil price declined from its multi-year highs due to recession fears, it remains elevated.
Zacks Industry Rank Indicates Bright Prospects
The Zacks Railroad industry, housed within the broader Zacks Transportation sector, currently carries a Zacks Industry Rank #93. This rank places it in the top 37% of more than 250 Zacks industries.
The group’s Zacks Industry Rank, basically the average of the Zacks Rank of all the member stocks, implies encouraging near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperform the bottom 50% by a factor of more than 2 to 1. The industry’s position in the top 50% of the Zacks-ranked industries is a result of a positive earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are gradually gaining confidence in this group’s earnings growth potential. The industry’s earnings estimate has been revised 1.1% upward since June-end.
Given the bullish near-term prospects of the industry, we will present a few noteworthy stocks that you may want to hold in your portfolio. But it’s worth looking at the industry’s shareholder returns and its current valuation first.
Industry's Price Performance
Over the past year, the Zacks Transportation - Rail industry has declined 6.1% compared with the S&P 500 composite’s fall of 15.1% and the broader sector’s decrease of 12%.
One-Year Price Performance
Industry's Current Valuation
Based on the trailing 12-month price-to-book (P/B), a commonly used multiple for valuing railroad stocks, the industry is currently trading at 7.41X compared with the S&P 500’s 5.61X. It is also above the sector’s P/B ratio of 4.27X.
Over the past five years, the industry has traded as high as 10.86X, as low as 5.69X and at the median of 8.08X as the chart below shows.
4 Railroad Stocks to Keep Tabs on
Each of the stocks mentioned below currently carries a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
Union Pacific: Based in Omaha, NE, Union Pacific provides rail transportation services across the United States.
With economic activities gaining pace, freight revenues, accounting for the bulk of UNP's top line, are improving. In the first nine months of 2022, freight revenues improved 16% year over year. Segmentwise, freight revenues in the first nine months of 2022 increased 16%, 14% and 19% in the bulk, industrial and premium units, respectively. The Zacks Consensus Estimate for UNP’s 2022 earnings is pegged at 15.8% growth from the 2021 reported number.
Price and Consensus: UNP
Canadian Pacific: Headquartered in Calgary, Canada, Canadian Pacific operates a transcontinental railway network in Canada and the United States.
With the gradual recovery in freight-market conditions, freight revenues, contributing considerably to the top line, increased 4% in 2021. In third-quarter 2022, freight revenues increased 19% despite headwinds like supply-chain woes remaining.The increase was owing to higher freight revenues at key sub-groups like intermodal where freight revenues surged 44%. Revenues at the Fertilizers and sulphur sub-segment were up 11% year over year. In the September quarter, total freight revenues per revenue ton-miles (RTMs) rose 11% year over year. Total freight revenues per carload rose 7% from the year-ago quarter’s reported figure. The Zacks Consensus Estimate for CP’s 2022 revenues is pegged at 1.8% growth from the 2021 actuals.
Price and Consensus: CP
CSX: Based in Jacksonville, FL, CSX offers rail-based freight transportation services like traditional rail service, and transport of intermodal containers and trailers besides rail-to-truck transfers.
CSX’s top line is benefiting from higher export coal volumes, solid domestic intermodal shipments, volume growth in other segments and pricing gains. Evidently, coal revenues increased 36% in the first nine months of 2022, driven by strength in export coal. Intermodal revenues increased 19% in the first nine months of 2022, led by strong demand, mainly on the domestic front. Demand is likely to remain strong going forward. The Zacks Consensus Estimate for CSX’s 2022 revenues stands at 22.4% growth from the year-ago reported figure.
Price and Consensus: CSX
Norfolk Southern: Headquartered in Atlanta, GA, Norfolk Southern is a major freight railroad company, primarily engaged in transporting raw material, intermediate products and finished goods.
A strong demand scenario prompted management to increase its current-year revenue growth outlook. Total revenues are now expected to increase above 13% in 2022 from the 2021 levels (earlier outlook: growth in excess of 12%). The intermodal and merchandise segments are expected to be the main drivers. Near-term opportunities are present in the coal segment too. Driven by revenue growth, reported the operating ratio (operating expenses as a percentage of revenues) is expected to be roughly 62% in 2022. The Zacks Consensus Estimate for NSC’s 2022 earnings stands at 13.6% growth from the year-ago reading.
Price and Consensus: NSC
Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report