The Railroad Trade: The Transport Stock Most Likely To Stay On Track

The North American logistics space represents a $1.2 trillion market, but some rail stocks appear to be out of favor with some Wall Street analysts.

The Analyst

Goldman Sachs' Matt Reustle initiated the following rail stocks with a Sell rating:

CSX Corporation CSX — $45 price target.
Union Pacific Corporation UNP — $103 price target.

The analyst also initiated Canadian National Railway (USA) CNI with a Buy rating and $85 price target.

The Thesis

Railroad stocks are trading with a valuation north of 20x LTM (last twelve months) earnings, but the transportation dynamics are shifting, Reustle said in a Monday note.

Supply chains are becoming more localized, with a greater need for shipping to be more flexible — which may bode well for trucking companies, the analyst said.

Goldman Sachs' proprietary carload forecast calls for a deceleration in rail growth from 4.5 percent this year to 1.3 percent in 2018, mostly due to declines in coal, grain and autos. On average, rail stocks have a downside potential of 2 percent, according to Goldman Sachs.

CSX: Investors Are Too Optimistic

CSX's recently appointed CEO Hunter Harrison has the necessary skills to turn around CSX's operating performance, but investors are likely overestimating the "speed and magnitude" of any earnings benefit, Reustle said.

Even if Harrison improves CSX's performance and achieves similar numbers to what he achieved leading Canadian Pacific Railway Limited (USA) CPI, CSX's stock valuation needs to be considered, Reustle said. CSX would be trading at 16.4x P/E if Harrison brings the company to similar levels as Canadian Pacific — putting CSX above its five-year average of 15.4x.

Union Pacific: Market Share Loss Being Ignored

Union Pacific is likely to lose the majority of its existing Midwest to Texas frac sand volumes, as local sand mines will enter service next year, Reustle said. The market is not factoring in Union Pacific's market share loss, which accounted for 5 percent of the company's entire EPS last year, the analyst said.

On top of that, the entire rail market is expected to see continued declines in coal carloads, which adds to the bearish case for Union Pacific, Reustle said. The analyst projects the company's 2018 and 2019 growth will fall short of the entire rail industry.

Canadian National: New Growth Investments

Canadian National is a standout in the rail sector and the lone stock under Goldman Sachs coverage with a Buy rating. This could be attributed to the company's strategic initiatives and investment to target energy-related products at a time when rival companies are right-sizing their respective asset bases, Reustle said.

Canadian National has targeted more than $1 billion in incremental revenue opportunities across intermodal, grain, metals, chemicals and energy which is estimated to drive 75 cents of EPS growth in the coming years, Reustle said.