All Aboard: 4 Railroad Stocks to Own - Investment Ideas

During the economic downturn, the railroad industry suffered more than most industries. That’s because the railroad business is closely tied to economic growth. When the economy fell into a deep recession, there wasn’t much demand for rail transport.

In response to the slowdown, railroads slashed costs, streamlined operations and increased productivity. Those moves helped the industry stem the bleeding and stabilize profit margins.

Improving Conditions

Now that the economy has rebounded and is in recovery mode, the railroad industry is making money hand over fist. Improved economic conditions are helping boost sales volumes. According to the Association of American Railroads, rail carloads increased 7.4% in the first half of 2010. Second-quarter carloads were up 13.4% in the second quarter. So far, carloads are up 13.0% in the third quarter.

Operating Leverage

Growing sales volumes coupled with the industry’s cost-cutting efforts have led to explosive earnings growth for railroad companies, as sales gains flow through to earnings. In addition, railroad companies can handle volume growth without a commensurate increase in expenses. This is due to efficient transportation networks and the ability to extend train lengths (adding train cars) at little cost. Through the second quarter of 2010, it appears the industry’s leaner cost structure is sustainable, and that bodes well for earnings growth in the next several quarters.

Valuations

Despite stellar earnings growth and better-than-expected earnings reports, many railroad stocks are trading at relatively cheap valuations. This suggests that the market is still focused on an economic slowdown in the second half of the year.

Nevertheless, railroad companies are expected to deliver impressive earnings growth in 2010 and strong double-digit growth in 2011. Yet it is easy to find railroad stocks that trade around 15x this year’s EPS estimates and 13x next year’s. In our view, that means expectations are too low on this group. That pessimism should offer some downside protection in the event that overall growth decelerates faster than the consensus expects.

Risks

The biggest risk facing the rail industry is a slowdown in overall economic activity. The recent GDP report shows that growth in this stage of the recovery is weak. If economic growth were to decelerate further, it would negatively impact sales volumes and earnings of the railroad industry. Another risk is the rising price of fuel, which could eat into railroad’s profit margins.

Here are four railroad stocks that deserve a closer look:

Canadian National Railway (CNI)

Canadian National Railway engages in the rail and related transportation business in North America. It provides transportation for various goods, including petroleum and chemicals, grain and fertilizers, coal, metals and minerals, forest products, and intermodal and automotive products.

The company reported second-quarter earnings of $1.08 per share, topping the Zacks Consensus by 10 cents, or 10.2%. Canadian National has beaten the Zacks Consensus in the last two quarters by an average of 8.4%.

In the last month, the Zacks Consensus Estimates for 2010 are up 13 cents, or 3.4%, to $3.93. The Zacks Consensus Estimate for 2011 is up 8 cents, or 1.8%, to $4.50.

CNI has a Zacks #2 Rank, and its shares trade at 13.8x 2010 EPS estimates and 14.3x 2011 EPS estimates.

CSX Corporation (CSX)

CSX Corp. provides rail-based transportation services in North America. The company offers traditional rail service, and the transport of intermodal containers and trailers.

For the second quarter, CSX earned $1.07 per share, an increase of 48.6% compared to the year-ago quarter. It also beat the Zacks Consensus by 10 cents, or 10.31%. In the last five quarters, CSX Corp. has beaten the Zacks Consensus Estimate by an average of 8.6%.

In the last month, the Zacks Consensus Estimates for 2010 are up 24 cents, or 6.7%, to $3.85. The Zacks Consensus Estimate for 2011 is up 20 cents, or 4.7%, to $4.46.

CSX is a Zacks #1 Rank stock. It trades at 13.9x 2010 consensus estimates and 12.0x 2011 consensus estimates.

Norfolk Southern (NSC)

Norfolk Southern engages in the rail transportation of raw materials, intermediate products and finished goods. Its operations consist of the transportation of coal, coke, iron ore products and automotive products.

For the second quarter, Norfolk Southern had EPS of $1.04, an increase of 57.5% compared to the second quarter of 2009. NSC beat the Zacks Consensus Estimate by 5 cents, or 5.1%. In the past two quarters, Norfolk Southern has beaten the Zacks Consensus Estimate by an average of 3.3%.

In the last month, the Zacks Consensus Estimates for 2010 is higher by 14 cents, or 3.8%, to $3.87, and the Zacks Consensus for 2011 is higher by 12 cents, or 2.7%, to $4.55.  

NSC is a Zacks #1 Rank stock that trades at 14.7x 2010 Zacks Consensus and 12.5x 2011 Zacks Consensus.

Union Pacific (UNP)

Union Pacific provides rail transportation services in North America. It has about 32,000 route miles linking Pacific Coast and Gulf Coast ports with the Midwest and eastern U.S. gateways.

The company had earnings of $1.40 per share, 19 cents, or 15.7%, ahead of the Zacks Consensus Estimate. Earnings were up 79.5% from the year-ago period.

In the last month, the Zacks Consensus Estimate for 2010 is up 20 cents, or 4.0%, to $5.16. The Zacks Consensus Estimate for 2011 is up 14 cents, or 2.4%, to $5.96.

This Zacks #2 Rank stock trades at 14.5x 2010 consensus EPS estimates and 12.5x 2011 consensus EPS estimates.
 
CDN NATL RY CO (CNI): Free Stock Analysis Report
 
CSX CORP (CSX): Free Stock Analysis Report
 
NORFOLK SOUTHRN (NSC): Free Stock Analysis Report
 
UNION PAC CORP (UNP): Free Stock Analysis Report
 
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