U.S. Markets closed

Near-Term Outlook for Railroad Industry Looks Promising

Zacks Equity Research

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. While freight constitutes the major chunk of revenues, some of these companies also derive a small portion of revenues from other rail-related services that include third-party railcar and locomotive repairs, routine land sales and container sales among others.

Let’s take a look at the industry’s three major themes:

  • Railroad companies make consistent efforts to improve operating ratio (operating expense as a percentage of revenues) in order to boost profits. The lower the value of the metric, the better it is. To this end, the precision scheduled railroading model has been proving to be immensely beneficial. With increased efficiency and reduced costs, railroad companies have shown consistent improvement in operating ratio, a key parameter for efficiency. Notable players that have adopted this model include CSX Corp. (CSX), Union Pacific Corp. (UNP), Canadian Pacific Railway Limited (CP) and Canadian National Railway Company (CNI). Most recently, Norfolk Southern Corp. (NSC) jumped on the bandwagon. While CSX aims to achieve an operating ratio of 60% this year, Union Pacific aims to reach the same level by 2020. Meanwhile, Norfolk Southern hopes to achieve a full-year operating ratio of 60% by 2021.

  • Growth of intermodal volumes in recent years is anticipated to drive railroads’ top line. Volumes at this key revenue generating unit rose 5.6% last year, thanks to an increasing number of freight conversions from highway to rail due to limited truck supply. Intermodal volumes are anticipated to witness a rise this year as well albeit at a slower pace since trucking capacity is expected to improve. However, an escalation of U.S.-China trade tensions might hurt volumes.

  • The scenario pertaining to coal, another key source of revenues for railroad companies, appears dull. Coal volumes have been declining over the past few years (except in 2017) due to slackening coal production as a result of low domestic consumption. Moreover, the U.S. Energy Information Administration (EIA) forecasts coal production to slide 4% this year, compared to that in 2018, and by a further 6% in 2020. Apart from competitive weakness in the electric power generation sector, the outlook assumes lower demand for U.S. coal exports.


Zacks Industry Rank Indicates Bright Prospects

The Zacks Railroad industry housed within the broader Zacks Transportation sector, currently carries a Zacks Industry Rank #58. This rank places it at the top 23% 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, indicates solid near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

The industry’s positioning in the top 50% of the Zacks-ranked industries is a result of positive earnings outlook for the constituent companies in aggregate. The groups’ current-year EPS estimate has increased more than 7% over the past year.

In light of the positivity, we will present a few stocks that you may want to consider for your portfolio. But, before that, it’s worth taking a look at the industry’s shareholder returns and current valuation.

Industry Outperforms Sector & S&P 500

The Zacks Rail industry has outperformed both the broader Transportation sector and the Zacks S&P 500 composite over the past year.

Over this period, the industry has rallied 18.9% compared with the broader sector’s 3.8% decline and the S&P 500 index’s 1% appreciation.

One-Year Price Performance



 

Industry’s Current Valuation

On the basis of trailing 12-month price-to-book (P/B) ratio, which is a commonly used multiple for valuing railroad stocks, the industry is currently trading at 4.67X compared with the S&P 500’s 3.68X. It is also above the sector’s P/B ratio of 3.16X.

Over the past five years, the industry has traded as high as 5.17X, as low as 2.22X and at the median of 4.17X as the chart below shows.

Price-to-Book Ratio

 

Price-to-Book Ratio


 

Bottom Line

Although coal volumes have historically contributed the maximum to rail carloads (volumes), with dwindling coal volumes, railroad companies have shifted their dependence to intermodal, which now reportedly dominates overall carloads. Apart from a low truck count, growing e-commerce demand is another factor fueling the growth of intermodal. Thus, the sluggish coal scenario is likely to be less of a hindrance for railroads. The precision scheduled railroading model should further foster growth of the companies.

Below we present one stock with a Zacks Rank #2 (Buy) that is taking full advantage of the buoyant scenario. There are also three more stocks with a Zacks Rank #3 (Hold) that investors may currently hold on to. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Union Pacific provides rail transportation services across several states in the United States through its principal operating company, Union Pacific Railroad Company. The Zacks Consensus Estimate for this Zacks Rank #2 company’s current-year EPS has been revised 1.5% upward in the last 60 days. The company has expected earnings per share growth of 10.7% over the next five years against the industry’s 9.7%.

Price and Consensus: UNP



 

Canadian Pacific operates a transcontinental railway network in Canada and the United States. The company is headquartered in Calgary, Canada. The Zacks Consensus Estimate for current-year EPS has been revised northward by 3 cents over the last 60 days. This Zacks Rank #3 company has expected earnings per share growth of 11.2% over the next five years, against the industry’s 9.7%.

Price and Consensus: CP



 

Norfolk Southern is primarily engaged in the rail transportation of raw material, intermediate products and finished goods, primarily in Southeast, East and Midwest United States. The Zacks Consensus Estimate for current-year EPS has been revised 1.7% north over the last 60 days. This Zacks Rank #3 company has expected earnings per share growth of 11.3% over the next five years against the industry’s 9.7%.

Price and Consensus: NSC



 

CSX is a leading rail freight carrier in North America, headquartered in Jacksonville, FL. The company carries a Zacks Rank of 3 and its Zacks Consensus Estimate for current-year EPS has moved approximately 1% upward in the last 60 days. The company has expected earnings per share growth of 13.4% over the next five years against the industry’s 9.7%.

Price and Consensus: CSX



 

Zacks' Top 10 Stocks for 2019

In addition to the stocks discussed above, wouldn't you like to know about our 10 finest buy-and-holds for the year?

From more than 4,000 companies covered by the Zacks Rank, these 10 were picked by a process that consistently beats the market. Even during 2018 while the market dropped -5.2%, our Top 10s were up well into double-digits. And during bullish 2012 – 2017, they soared far above the market's +126.3%, reaching +181.9%.

This year, the portfolio features a player that thrives on volatility, an AI comer, and a dynamic tech company that helps doctors deliver better patient outcomes at lower costs.

See Stocks Today >>


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
 
Union Pacific Corporation (UNP) : Free Stock Analysis Report
 
Norfolk Southern Corporation (NSC) : Free Stock Analysis Report
 
CSX Corporation (CSX) : Free Stock Analysis Report
 
Canadian Pacific Railway Limited (CP) : Free Stock Analysis Report
 
Canadian National Railway Company (CNI) : Free Stock Analysis Report
 
To read this article on Zacks.com click here.
 
Zacks Investment Research