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Railroads are so two centuries ago.

Except they're not.

Railroads now carry about 40% of all freight in the United States and that percentage may yet grow higher.

With increased shipping throughout the North American Free Trade zone, which includes Canada, the United States and Mexico, the railroads are investing in new track and hubs to expand their business.

Spotlight on Mexico

On May 29, with both New Mexico Governor Susana Martinez and Chihuahua Governor Cesar Duarte looking on, Union Pacific officially launched its new $400 million transportation hub near the southern border of New Mexico.

Completed a year early, the hub is expected to spur job development and open up business to Mexico.

Union Pacific said the hub can handle up to 225,000 containers and is on track to beat the initial first year estimate of 150,000 units.

Mexico is now the 8th largest auto manufacturer in the world. American manufacturers are also moving factories south of the border as Chinese labor becomes more expensive, putting costs in Mexico on par with those in Asia.

Parts and commodities are flowing from the north and finished cars and refrigerators are being shipped back to consumers in the United States and Canada.

Union Pacific controls 6 rail entries into Mexico. It also owns 26% of Ferromex, Mexico's largest railroad.

Kansas City Southern is also a big player in Mexico. It is the only American rail company with actual rail lines snaking across Mexico's interior. Its subsidiary, Kansas City Southern de México S.A., shares a concession with Ferromex that feeds into the important port city of Veracruz.

Kansas City Southern derives about 50% of its revenue from Mexico.

Energy Is Still a Growing Industry

Energy shipments by rail will remain an increasingly important part of the energy complex, even if large pipeline projects, like Keystone, are eventually built.

In Canada, according to the National Energy Board, shipments of crude by rail have jumped 900% since the start of 2012 to 146,047 barrels a day as production in the Alberta oil sands increased. But this still dwarfs the amount shipped by pipeline in Canada, which was 97% of total production.

Still, the rails are so busy in Canada that some farmers had trouble finding room on the trains to ship their grains last year.

In the United States, rail accounts for just 3% of all crude shipping methods. Even trucking was a higher percentage at 4%. But rail will continue to see volumes grow as it becomes a more popular way for oil companies to transport crude.

Is It Too Late To Get In?

Investors have figured out the railroad story. They have piled into the major American and Canadian railroad companies and have pushed the stocks up to new all-time highs.

Should you be buying these stocks now?

This is an industry that is still experiencing double digit earnings growth. Valuations, while on the high side historically, also aren't excessive.

With the energy, chemical and agriculture sectors still strong, and coal starting to recover, the future for the rails looks brighter than ever.

Three Hot Railroad Stocks

There are only so many railroads in the United States, Canada and Mexico. The Zacks Railroad Industry has a list of 7 companies.

Even though the entire industry is strong, I narrowed down that list to the 3 companies with the best Zacks Rank and strong fundamentals, including double digit earnings growth.

  1. Union Pacific
  2. Kansas City Southern
  3. Canadian National Railway
1. Union Pacific Corporation (UNP - Analyst Report)

Union Pacific services 23 western states and the Gulf Coast shipping agricultural products, automotive, chemicals, industrial products, coal and intermodal. It is the only railroad that operates at all 6 gateways to Mexico.

The recently opened $400 million Santa Teresa, New Mexico rail facility, which includes a fueling station, crew change buildings and an intermodal ramp, provides the company with a key access point to Mexico. It will also create greater efficiencies along its Sunset Route, the 760 mile rail line from El Paso, Texas to Los Angeles.

Forward P/E = 18.3
Expected 2014 Earnings Growth = 16%
Expected 2015 Earnings Growth = 14%
Dividend Yield = 1.8%
Zacks Rank #2 (Buy)

2. Kansas City Southern (KSU - Analyst Report)

Kansas City Southern was the first railroad in the United States established with a north-south axis with the dream of shipping lumber and other commodities from the central states to the Gulf Coast. Recent expansion into Mexico has given Kansas City Southern the only fully-owned rail lines connecting Mexico City and the port city of Veracruz with Texas shipping hubs.

Forward P/E = 23
Expected 2014 Earnings Growth = 17%
Expected 2015 Earnings Growth = 16%
Dividend Yield = 1%
Zacks Rank #2 (Buy)

3. Canadian National Railway Company (CNI - Analyst Report)

Canadian National Railway operates a transcontinental Canadian railroad servicing the ports of Vancouver, Montreal and Halifax and large metropolitan areas of Toronto Edmonton, Winnipeg and Calgary. In the United States it also connects to New Orleans, Mobile, Chicago, Memphis and Detroit.

It ships agriculture, chemicals and industrial products and is also discussion to ship Alberta oil sands crude on the rails to the United States for refining.

Forward P/E = 18.8
Expected 2014 Earnings Growth = 18%
Expected 2015 Earnings Growth = 13%
Dividend Yield = 1.5%
Zacks Rank #3 (Hold)

Transportation Is Still Key

While it may seem like the railroads are part of the "old" economy, they have become a vital component in the operation and success of NAFTA and in the movement of goods across the entire North American continent.

As the North American economy heats up, it will be the rails that will be the prime beneficiaries.

It's not too late to jump aboard.

[In full disclosure, the author of this article owns shares of KSU.]

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Tracey Ryniec is the Value Stock Strategist for Zacks.com. She is also the Editor of the Insider Trader and Value Investor services. You can follow her on twitter at @TraceyRyniec.

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