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Railroad Industry's Near-Term Outlook Dull on Freight Woes
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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 their top line 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:
With coal being a key revenue generating commodity for railroads, its declining volumes are a major setback to the industry. Reduced domestic consumption, weak export demand and competitive disadvantage due to low natural gas prices are all contributing to soft volumes. This dim scenario is likely to continue as per the Energy Information Administration (EIA) annual forecasts for coal consumption and production in 2019 and 2020.
Weakness in Intermodal, another important source of revenues for railroads, is also posing a threat to the industry. While increased truck capacity and lower prices are impacting domestic intermodal volumes, trade-related uncertainty is affecting international intermodal volumes. Evidently, major railroad player, CSX Corporation (CSX - Free Report) expects its top line to decline 1-2% in 2019 primarily due to its persistent battle with sluggish Intermodal volumes. Trade tensions between the United States and China are not only affecting intermodal volumes, but overall freight volumes. Per the Association of American Railroads (AAR), rail traffic decreased in each of the 10 months of 2019. Due to this major downturn in freight, Union Pacific Corporation (UNP - Free Report) expects current-year volumes to decline in mid-single digits.
The railroad companies are benefiting immensely from the precision scheduled railroading model, an operating structure that reduces costs, enhances services and leads to optimal asset utilization. Notable players that have adopted this model include CSX, Union Pacific, Norfolk Southern Corporation (NSC - Free Report) , Canadian Pacific Railway Limited (CP - Free Report) and Canadian National Railway Company (CNI - Free Report) . With increased efficiency and reduced costs, these railroad players have shown consistent improvement in operating ratio (operating expense as a percentage of revenues), and hope for even better in the near future. While CSX aims to achieve an operating ratio of below 60% (60.3% reported in 2018) this year, Union Pacific targets an operating ratio of below 61% compared with 61.6% achieved last year. Moreover, Union Pacific expects this key measure of efficiency to be below 60% by 2020.
Zacks Industry Rank Indicates Bleak Prospects
The Zacks Railroad industry housed within the broader Zacks Transportation sector currently carries a Zacks Industry Rank #214. This rank places it at the bottom 15% 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 dull 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 bottom 50% of the Zacks-ranked industries is a result of negative earnings outlook for the constituent companies in aggregate. The groups’ current-year EPS estimate has decreased 1.7% since November 2018.
Despite the pessimism, we will present a few noteworthy stocks. 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 15.8% compared with the broader sector and the S&P 500 Index’s 5% and 13.1% appreciation, respectively.
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 5.25X compared with the S&P 500’s 4.39X. It is also above the sector’s P/B ratio of 3.29X.
Over the past five years, the industry has traded as high as 5.73X, as low as 2.22X and at the median of 4.36X as the chart below shows.
Price-to-Book Ratio
Price-to-Book Ratio
Bottom Line
Sluggish freight demand due to the long-standing U.S.-China trade tensions is squeezing profit margins and limiting top-line growth of railroad companies. In this challenging environment, the railroads’ cost-cutting measures and improving efficiency, courtesy of precision scheduled railroading, is helping to partly offset this adversity. However, the overall outlook for the near term looks dim until the freight scene improves.
Nevertheless, below we present one stock with a Zacks Rank #2 (Buy) that is poised to grow amid challenges. There are also two 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.
Kansas City Southern is a transportation holding company based in Kansas City, MO. The Zacks Consensus Estimate for this Zacks Rank #2 company’s current-year EPS has been revised upward 3.1% in the last 60 days. It also has an expected earnings per share growth of 15% over the next five years against the industry’s 8.9%.
Price and Consensus: KSU
CSX is one of United States’ leading transportation companies based in Jacksonville, FL. The Zacks Consensus Estimate for this Zacks Rank #3 company’s current-year EPS has been revised northward 1.2% in the last 60 days. Moreover, it has an expected earnings per share growth of 12.8% over the next five years against the industry’s 8.9%.
Price and Consensus: CSX
West Japan Railway Company (WJRYY - Free Report) is a rail transportation company based in Osaka, Japan. This company also carries a Zacks Rank of 3. Shares of the company have rallied 29.3% in a year against the industry’s 15.7% rise.
Price and Consensus: WJRYY
5 Stocks Set to Double
Each was hand-picked by a Zacks expert as the #1 favorite stock to gain +100% or more in 2020. Each comes from a different sector and has unique qualities and catalysts that could fuel exceptional growth.
Most of the stocks in this report are flying under Wall Street radar, which provides a great opportunity to get in on the ground floor.
Image: Bigstock
Railroad Industry's Near-Term Outlook Dull on Freight Woes
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 their top line 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:
With coal being a key revenue generating commodity for railroads, its declining volumes are a major setback to the industry. Reduced domestic consumption, weak export demand and competitive disadvantage due to low natural gas prices are all contributing to soft volumes. This dim scenario is likely to continue as per the Energy Information Administration (EIA) annual forecasts for coal consumption and production in 2019 and 2020.
Weakness in Intermodal, another important source of revenues for railroads, is also posing a threat to the industry. While increased truck capacity and lower prices are impacting domestic intermodal volumes, trade-related uncertainty is affecting international intermodal volumes. Evidently, major railroad player, CSX Corporation (CSX - Free Report) expects its top line to decline 1-2% in 2019 primarily due to its persistent battle with sluggish Intermodal volumes. Trade tensions between the United States and China are not only affecting intermodal volumes, but overall freight volumes. Per the Association of American Railroads (AAR), rail traffic decreased in each of the 10 months of 2019. Due to this major downturn in freight, Union Pacific Corporation (UNP - Free Report) expects current-year volumes to decline in mid-single digits.
The railroad companies are benefiting immensely from the precision scheduled railroading model, an operating structure that reduces costs, enhances services and leads to optimal asset utilization. Notable players that have adopted this model include CSX, Union Pacific, Norfolk Southern Corporation (NSC - Free Report) , Canadian Pacific Railway Limited (CP - Free Report) and Canadian National Railway Company (CNI - Free Report) . With increased efficiency and reduced costs, these railroad players have shown consistent improvement in operating ratio (operating expense as a percentage of revenues), and hope for even better in the near future. While CSX aims to achieve an operating ratio of below 60% (60.3% reported in 2018) this year, Union Pacific targets an operating ratio of below 61% compared with 61.6% achieved last year. Moreover, Union Pacific expects this key measure of efficiency to be below 60% by 2020.
Zacks Industry Rank Indicates Bleak Prospects
The Zacks Railroad industry housed within the broader Zacks Transportation sector currently carries a Zacks Industry Rank #214. This rank places it at the bottom 15% 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 dull 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 bottom 50% of the Zacks-ranked industries is a result of negative earnings outlook for the constituent companies in aggregate. The groups’ current-year EPS estimate has decreased 1.7% since November 2018.
Despite the pessimism, we will present a few noteworthy stocks. 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 15.8% compared with the broader sector and the S&P 500 Index’s 5% and 13.1% appreciation, respectively.
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 5.25X compared with the S&P 500’s 4.39X. It is also above the sector’s P/B ratio of 3.29X.
Over the past five years, the industry has traded as high as 5.73X, as low as 2.22X and at the median of 4.36X as the chart below shows.
Price-to-Book Ratio
Price-to-Book Ratio
Bottom Line
Sluggish freight demand due to the long-standing U.S.-China trade tensions is squeezing profit margins and limiting top-line growth of railroad companies. In this challenging environment, the railroads’ cost-cutting measures and improving efficiency, courtesy of precision scheduled railroading, is helping to partly offset this adversity. However, the overall outlook for the near term looks dim until the freight scene improves.
Nevertheless, below we present one stock with a Zacks Rank #2 (Buy) that is poised to grow amid challenges. There are also two 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.
Kansas City Southern is a transportation holding company based in Kansas City, MO. The Zacks Consensus Estimate for this Zacks Rank #2 company’s current-year EPS has been revised upward 3.1% in the last 60 days. It also has an expected earnings per share growth of 15% over the next five years against the industry’s 8.9%.
Price and Consensus: KSU
CSX is one of United States’ leading transportation companies based in Jacksonville, FL. The Zacks Consensus Estimate for this Zacks Rank #3 company’s current-year EPS has been revised northward 1.2% in the last 60 days. Moreover, it has an expected earnings per share growth of 12.8% over the next five years against the industry’s 8.9%.
Price and Consensus: CSX
West Japan Railway Company (WJRYY - Free Report) is a rail transportation company based in Osaka, Japan. This company also carries a Zacks Rank of 3. Shares of the company have rallied 29.3% in a year against the industry’s 15.7% rise.
Price and Consensus: WJRYY
5 Stocks Set to Double
Each was hand-picked by a Zacks expert as the #1 favorite stock to gain +100% or more in 2020. Each comes from a different sector and has unique qualities and catalysts that could fuel exceptional growth.
Most of the stocks in this report are flying under Wall Street radar, which provides a great opportunity to get in on the ground floor.
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