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4 Top Railroad Stocks to Benefit from Strong Freight Demand

·7 min read

The Zacks Transportation - Rail industry is thriving on a steady improvement in freight demand. The buoyant U.S. economy is driving growth for railroads.  Despite these tailwinds, the industry is being plagued by escalating fuel prices, thanks to the Russia-Ukraine war.

Companies like Union Pacific Corporation UNP, Canadian Pacific Railway Limited CP, CSX Corporation CSX and Norfolk Southern Corporation NSC are expected to ride on upbeat freight demand.


About the Industry

The Zacks Transportation - Rail industry consists of railroad operators that transport 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 the major 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 an 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 despite declining from the 2021 levels due to a shift in consumer spending from goods to services as pandemic fears relent and a deceleration in inventory restocking by businesses. The Cass Freight Index rose 0.4% on a year-over-year basis in July (shipment reading for the month stands at 1.182) after a 2.3% decline in June (shipment reading for the month stands at 1.203). 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 as the U.S. economy remains buoyant.

Dividend Hikes Reflect 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. In May 2022, UNP upped its dividend 10% to $1.30 per share. In February 2022, CSX’s board cleared a 7.5% increase in its quarterly dividend payout, taking the total to 10 cents per share.

Supply-Chain Disruptions Stay: Persistent supply-chain disturbances, including labor and equipment shortages, are hurting railroad volumes in some segments, especially the intermodal unit. The Association of American Railroads’ latest rail traffic data shows that the total U.S. intermodal volumes declined 3.2% year over year in the first 30 weeks of 2022. Supply-chain bottlenecks are likely to persist for a while now, posing a threat to intermodal volumes.

Escalating Fuel Prices a Bane: Fuel expenses are a major input cost for the transportation companies. Skyrocketing fuel prices, thanks to the Russia-Ukraine war, strain the railroad companies’ bottom line. Amid coronavirus-related uncertainties, rising fuel prices might further impede the railroad companies’ growth. The oil price flared up 48% in first-half 2022.

Zacks Industry Rank Indicates Bright Prospects

The Zacks Railroad industry, housed within the broader Zacks Transportation sector, currently carries a Zacks Industry Rank #91. This rank places it in the top 36% of more than 250 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, implies rosy 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 0.4% upward since March-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 Outperforms Sector, S&P 500

The Zacks Railroad industry has outperformed the broader Transportation sector and the Zacks S&P 500 composite index in the past year.

Over this period, the industry has inched up 2.4% against the sector and the S&P 500 Index’s fall of 10.2% and 12.3%, respectively.

One-Year Price Performance

One-Year Price Performance
One-Year Price Performance

Industry's Current Valuation

On the basis of 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 5.64X. It is also above the sector’s P/B ratio of 4.63X.

Over the past five years, the industry has traded as high as 10.86X, as low as 5.69X and at the median of 8.09X as the chart below shows.

Price-to-Book Ratio

PB RATIO
PB RATIO




Price-to-Book Ratio

pb ratio
pb ratio


4 Railroad Stocks to Keep Tabs on

Each of the stocks mentioned below 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.

Higher volumes, pricing and a positive business mix are fuelling Union Pacific’s growth.  UNP expects volume growth to be stronger in the second half of 2022 than the first-half level. Management expects 2022 volumes (carloads) to grow in the 4-5% band.

With economic activities picking up the pace, freight revenues, accounting for the bulk of a company's top line, are improving. Freight revenues improved 11% year over year in 2021. In first-half 2022, freight revenues climbed 15% year over year. Segmentwise, freight revenues in the first six months of 2022 increased 15%, 14% and 17% in the bulk, industrial and premium units, respectively. The Zacks Consensus Estimate for UNP’s 2022 earnings is pegged at a rise of 14.3% from the 2021 reported number.

Price and Consensus: UNP

UNP
UNP

 

CSX: Based in Jacksonville, FL, CSX offers rail-based freight transportation services like traditional rail service, transport of intermodal containers and trailers, besides rail-to-truck transfers.

CSX’s top line is benefiting from higher export coal volumes, domestic intermodal shipments and volume growth in other segments as well as pricing gains. Coal revenues jumped 47% in first-half 2022, driven by strength in export coal. Intermodal revenues ascended 15% in first-half 2022, led by strong demand, mainly on the domestic front. The Zacks Consensus Estimate for 2022 revenues stands at an increase of 6.2% from the year-ago reported number.

Price and Consensus: CSX

CSX
CSX

 

Canadian Pacific: Headquartered in Calgary, Canada, Canadian Pacific operates a transcontinental railway network in Canada and the United States.

Canadian Pacific’s buyout of Kansas City Southern last December is expected to boost growth. CP is benefiting from higher freight rates owing to strong freight market conditions. CP’s commitment to rewarding its shareholders is encouraging. The company paid out dividends worth C$507 million in 2021, up 8.6% year over year. In second-quarter 2022, CP shelled out dividends worth C$176 million, up 39.6% year over year. The Zacks Consensus Estimate for CSX’s 2022 earnings is pegged at growth of 21.2% from the prior-year reported figure.

Price and Consensus: CP

CP
CP

 

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.

Despite coronavirus-related woes, Norfolk Southern is committed to rewarding its shareholders.  In January 2022, NSC's board announced a 14% increase in its quarterly dividend payout. This was the third dividend hike announced in a year’s time. During the first half of 2022, NSC paid out dividends worth $591 million, up 2% year over year. It repurchased and retired common stock worth $1454 million in first-half 2022.  The strong demand scenario prompted management to increase the current-year revenue growth outlook. Total revenues are now expected to exceed 12% growth in 2022 from the 2021 levels (earlier outlook: upper single digit in percentage terms). The intermodal and merchandise segments are expected to be the key catalysts. The Zacks Consensus Estimate for 2022 earnings is pegged at a 12.8% jump from the year-ago reported figure.

Price and Consensus: NSC

NSC
NSC




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