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Railroads' Near-Term Outlook Looks Dim on Coronavirus 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 including 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:
Global economic slowdown caused by the coronavirus pandemic began to take its toll on railroads mainly in March. With several countries under lockdown, the situation worsened in April, evident from a record 25% year over year decline in volumes (total rail carloads). With the re-opening of economies, volumes have improved from the April lows, but is still significantly below year-ago levels. The Association of American Railroads’ latest traffic data shows that total carloads for the week ending Jul 11 have declined 22.7% from the same week in 2019.
The United States–Mexico–Canada Agreement (“USMCA”) agreement which came into effect on Jul 1 is a major boon to North American railroads. Replacing the 25-year old North American Free Trade Agreement (“NAFTA”), the USMCA streamlines North American trade and is expected to boost volumes for railroads. Additionally, the precision scheduled railroading (“PSR”) model continues to benefit railroads by reducing costs and increasing efficiencies. For instance, Kansas City Southern is expected to generate savings of $95 million in 2020 due to operating expense reduction, thanks to the PSR model. With increased efficiency owing to the PSR model, Norfolk Southern Corporation (NSC - Free Report) has shown consistent improvement in operating ratio (operating expenses as a percentage of revenues).
Due to the capital intensive nature of the business, railroad companies usually carry a lot of debt burden. For instance, Union Pacific Corporation (UNP - Free Report) , CSX Corporation (CSX - Free Report) and Canadian Pacific Railway Limited (CP - Free Report) have a long-term debt-to-equity ratio of more than 1. A high debt-to-equity ratio implies that the company is funding most of its ventures with debt, which can be detrimental to its financial health.
Zacks Industry Rank Indicates Gloomy Prospects
The Zacks Railroad industry housed within the broader Zacks Transportation sector currently carries a Zacks Industry Rank #204. This rank places it at the bottom 19% 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 bleak 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 group's current-year EPS estimate has decreased 21.8% over the past year.
Despite the industry’s drab near-term prospects, we will present a few stocks which you should consider for your portfolio. But before that, it’s worth taking a look at the industry’s stock market performance and current valuation.
Industry Outperforms Sector But Underperforms S&P 500
The Zacks Rail industry has outperformed the broader Transportation sector over the past year, but has underperformed the S&P 500 composite index.
Over this period, the industry has increased 3.3% compared with the broader sector’s decrease of 5.8% and the S&P 500 Index’s 9.8% rise.
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 5.56X, compared with the S&P 500’s 4.46X. It is also above the sector’s P/B ratio of 3.4X.
Over the past five years, the industry has traded as high as 5.98X, as low as 2.81X and at the median of 4.51X as the chart below shows.
Price-to-Book Ratio
Price-to-Book Ratio
Bottom Line
The precision scheduled railroading model should continue to support railroads’ bottom line. The enforcement of the USMCA agreement provides a further boost to railroads. However, these benefits are unlikely to offset the challenges posed by coronavirus in the near term. With volumes way below year-ago levels and a recovery not likely in the near future, the railroad companies’ top line is anticipated to remain under pressure.
Below we present two stocks with a Zacks Rank #1 (Strong Buy) and 2 (Buy), which are poised to grow amid challenges. We also have two other stocks with a Zacks Rank #3 (Hold), which you may retain in your portfolio. You can see the complete list of today’s Zacks #1 Rank stocks here.
Canadian Pacific operates a transcontinental railway network in Canada and the United States. The company focuses on providing logistics and supply chain expertise services.
The Zacks Consensus Estimate for this Zacks #1 Ranked company’s current-year EPS has been revised upward by 5.3% over the past 60 days. It also has a stellar earnings history, having trumped the Zacks Consensus Estimate in each of the trailing four quarters by 4.9%, on average.
Price and Consensus: CP
Canadian National Railway Company (CNI - Free Report) is engaged in the rail and related transportation business. The company is based in Montreal, Canada.
This company carries a Zacks Rank #2 and the Zacks Consensus Estimate for its current-year EPS has been revised northward by 3.1% over the past 60 days. It also has an impressive earnings history having outperformed the Zacks Consensus Estimate by 7.5% in the preceding four quarters, on average.
Price and Consensus: CNI
Kansas City Southern is a transportation holding company that has railroad investments in the United States, Mexico and Panama.
The company has an excellent earnings history having surpassed the Zacks Consensus Estimate by 7% in the trailing four quarters, on average.
Price and Consensus: KSU
Union Pacific provides rail transportation services across the United States.
The Zacks Consensus Estimate for the company’s current-year earnings has been revised upward by 3 cents over the past 60 days.
Price and Consensus: UNP
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Railroads' Near-Term Outlook Looks Dim on Coronavirus 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 including 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:
Global economic slowdown caused by the coronavirus pandemic began to take its toll on railroads mainly in March. With several countries under lockdown, the situation worsened in April, evident from a record 25% year over year decline in volumes (total rail carloads). With the re-opening of economies, volumes have improved from the April lows, but is still significantly below year-ago levels. The Association of American Railroads’ latest traffic data shows that total carloads for the week ending Jul 11 have declined 22.7% from the same week in 2019.
The United States–Mexico–Canada Agreement (“USMCA”) agreement which came into effect on Jul 1 is a major boon to North American railroads. Replacing the 25-year old North American Free Trade Agreement (“NAFTA”), the USMCA streamlines North American trade and is expected to boost volumes for railroads. Additionally, the precision scheduled railroading (“PSR”) model continues to benefit railroads by reducing costs and increasing efficiencies. For instance, Kansas City Southern is expected to generate savings of $95 million in 2020 due to operating expense reduction, thanks to the PSR model. With increased efficiency owing to the PSR model, Norfolk Southern Corporation (NSC - Free Report) has shown consistent improvement in operating ratio (operating expenses as a percentage of revenues).
Due to the capital intensive nature of the business, railroad companies usually carry a lot of debt burden. For instance, Union Pacific Corporation (UNP - Free Report) , CSX Corporation (CSX - Free Report) and Canadian Pacific Railway Limited (CP - Free Report) have a long-term debt-to-equity ratio of more than 1. A high debt-to-equity ratio implies that the company is funding most of its ventures with debt, which can be detrimental to its financial health.
Zacks Industry Rank Indicates Gloomy Prospects
The Zacks Railroad industry housed within the broader Zacks Transportation sector currently carries a Zacks Industry Rank #204. This rank places it at the bottom 19% 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 bleak 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 group's current-year EPS estimate has decreased 21.8% over the past year.
Despite the industry’s drab near-term prospects, we will present a few stocks which you should consider for your portfolio. But before that, it’s worth taking a look at the industry’s stock market performance and current valuation.
Industry Outperforms Sector But Underperforms S&P 500
The Zacks Rail industry has outperformed the broader Transportation sector over the past year, but has underperformed the S&P 500 composite index.
Over this period, the industry has increased 3.3% compared with the broader sector’s decrease of 5.8% and the S&P 500 Index’s 9.8% rise.
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 5.56X, compared with the S&P 500’s 4.46X. It is also above the sector’s P/B ratio of 3.4X.
Over the past five years, the industry has traded as high as 5.98X, as low as 2.81X and at the median of 4.51X as the chart below shows.
Price-to-Book Ratio
Price-to-Book Ratio
Bottom Line
The precision scheduled railroading model should continue to support railroads’ bottom line. The enforcement of the USMCA agreement provides a further boost to railroads. However, these benefits are unlikely to offset the challenges posed by coronavirus in the near term. With volumes way below year-ago levels and a recovery not likely in the near future, the railroad companies’ top line is anticipated to remain under pressure.
Below we present two stocks with a Zacks Rank #1 (Strong Buy) and 2 (Buy), which are poised to grow amid challenges. We also have two other stocks with a Zacks Rank #3 (Hold), which you may retain in your portfolio. You can see the complete list of today’s Zacks #1 Rank stocks here.
Canadian Pacific operates a transcontinental railway network in Canada and the United States. The company focuses on providing logistics and supply chain expertise services.
The Zacks Consensus Estimate for this Zacks #1 Ranked company’s current-year EPS has been revised upward by 5.3% over the past 60 days. It also has a stellar earnings history, having trumped the Zacks Consensus Estimate in each of the trailing four quarters by 4.9%, on average.
Price and Consensus: CP
Canadian National Railway Company (CNI - Free Report) is engaged in the rail and related transportation business. The company is based in Montreal, Canada.
This company carries a Zacks Rank #2 and the Zacks Consensus Estimate for its current-year EPS has been revised northward by 3.1% over the past 60 days. It also has an impressive earnings history having outperformed the Zacks Consensus Estimate by 7.5% in the preceding four quarters, on average.
Price and Consensus: CNI
Kansas City Southern is a transportation holding company that has railroad investments in the United States, Mexico and Panama.
The company has an excellent earnings history having surpassed the Zacks Consensus Estimate by 7% in the trailing four quarters, on average.
Price and Consensus: KSU
Union Pacific provides rail transportation services across the United States.
The Zacks Consensus Estimate for the company’s current-year earnings has been revised upward by 3 cents over the past 60 days.
Price and Consensus: UNP
Just Released: Zacks’ 7 Best Stocks for Today
Experts extracted 7 stocks from the list of 220 Zacks Rank #1 Strong Buys that has beaten the market more than 2X over with a stunning average gain of +24.1% per year.
These 7 were selected because of their superior potential for immediate breakout.
See these time-sensitive tickers now >>