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Buy 5 Top Railroad Operators on Strong Freight Growth

Nalak Das
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Buy 5 Top Railroad Operators on Strong Freight Growth

The robust financial health of railroads bears testimony to the fact that the scenario has improved considerably for players in this industry despite coal-related headwinds.

The railroad industry seems to be poised well not only in the near term but also in the long haul on the back of robust freight demand driven by a buoyant U.S. economy. A strong U.S. economy supports the bullishness of freight railroad operators, as it implies that more goods are being transported across the country.

The robust financial health of railroads bears testimony to the fact that the scenario has improved considerably for players in this industry despite coal-related headwinds. At this stage, it will be a prudent move to invest in freight railroad stocks with a favorable Zacks Rank and strong growth potential.

Solid U.S. Economic Fundamentals

Freight railroad is vital for domestic freight as it accounts for around 40% of the U.S. transportation sector. The thriving U.S. economy is highly conducive to growth of railroads. The improved scenario is evident from U.S. GDP’s record growth of 3.3% in the first nine months of 2018, surpassing the target of 3% set by President Trump.

The two pro-growth strategies of Trump, namely, significant cut in corporate taxes and deregulation are major catalysts to the railroad industry. Freight railroad operators book much of their revenues in the homeland. Consequently, reductions in corporate tax rate from 35% to 21% borne by railroads’ become immediately accretive to cash flow.

Strong Intermodal Business

Intermodal segment has improved significantly in 2018. In the first 42 weeks of 2018, intermodal volumes rose 5.7% year over year to 11,691,908 units. Strong intermodal volumes have been bolstering railroads’ top line and the uptrend is likely to continue going forward. Improving prospects of intermodal segment has been benefiting railroads since the beginning of the year. Further, the railroad operators’ sustained cost-reduction efforts are anticipated to drive the bottom line going forward.

Robust AAR Data

The Association of American Railroads (“AAR”), the industry body of the class 1 freight railroad operators, reported that U.S. rail traffic (including carloads and intermodal units) was pegged at 555,106 for the week ended Oct 20, 2018. This reflects year-over-year increase of 0.5%. Half of the 10 carload commodity groups reported an increase compared with the same week in 2017. Total U.S. rail traffic for the first 42 weeks of 2018 was 11,047,756 carloads, up 1.8% year over year.

Additionally, railroads have been witnessing an improvement pertaining to another key metric -- operating ratio (operating expenses as a percentage of revenues) in 2018. The lesser the value of operating ratio, the better, as it implies that more cash is available to the company to reward shareholders through hike in dividends or share buybacks.

Our Top Picks

Economic growth and demand for freight are positively correlated. With high freight demand, the railroad industry clearly stands to gain. Consequently, it will be lucrative to invest in freight railroad stocks. We have narrowed down our search to five stocks carrying either Zacks Rank #1 (Strong Buy) and 2 (Buy) with strong growth potential.

The chart below depicts price performance of our five picks year to date.

CSX Corp. CSX is a premier transportation company providing rail, intermodal and rail-to-truck trans-load services and solutions to customers. It sports a Zacks Rank #1. You can see the complete list of today’s Zacks #1 Rank stocks here. The companyhas expected earnings growth of 65.2% for the current year. The Zacks Consensus Estimate for the current year has improved by 5.2% over the last 30 days.

Canadian Pacific Railway Ltd. CP is North America's first transcontinental railway and is the only transcontinental carrier with direct service to the U.S. eastern seaboard. It flaunts a Zacks Rank #1. The company has expected earnings growth of 23.1% for the current year. The Zacks Consensus Estimate for the current year has improved by 5.6% over the last 30 days.

Union Pacific Corp. UNP is one of America's leading transportation companies. Its principal operating company, Union Pacific Railroad, is North America's premier railroad franchise. It carries a Zacks Rank #2. The company has expected earnings growth of 35.2% for the current year. The Zacks Consensus Estimate for the current year has improved by 0.8% over the last 30 days.

Norfolk Southern Corp. NSC is one of the United States’ premier railroad operators. It carries a Zacks Rank #2. The company has expected earnings growth of 39.6% for the current year. The Zacks Consensus Estimate for the current year has improved by 1% over the last 30 days.

Canadian National Railway Co. CNI operates the larger of Canada's two principal railroads. It is also the only coast-to-coast railroad network in North America. It carries a Zacks Rank #2. The company has expected earnings growth of 9.1% for the current year. The Zacks Consensus Estimate for the current year has improved by 0.5% over the last 30 days.

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