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4 Railroad Stocks to Keep an Eye on Amid COVID-Led Freight Woes

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Coronavirus-induced freight softness is weighing on Zacks Transportation - Rail industry’s prospects. The railroads’ top line is under pressure due to weak volumes. While volumes have improved substantially from the lows in April and May, it is still weak on a year-over-year basis. With the pandemic showing no signs of fading, railroad volumes are likely to remain weak in the near term.

Amid adversities, benefits of the precision scheduled railroading (“PSR”) model, in the form of reduced costs, are helping railroads stay afloat. In this respect, railroad players namely Union Pacific Corporation (UNP - Free Report) , CSX Corporation (CSX - Free Report) , Norfolk Southern Corporation (NSC - Free Report) and Kansas City Southern (KSU - Free Report) are noteworthy.

About the Industry

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.

3 Trends Shaping the Future of the Railroad Industry

Coronavirus-Induced Freight Woes: Slowdown in the global economy due to coronavirus-led disruptions is weighing on railroad volumes. While volumes have improved significantly from the dramatic lows in April and May, it is still weak when compared with the year-ago levels. The Association of American Railroads’  latest traffic data shows that total carloads (volumes) for the week ending Nov 21, 2020 have declined 7.2% from the same week in 2019. This softness in volumes is hurting freight revenues, which contribute the lion’s share of the top lines of most railroads. Union Pacific, suffering substantial decline in freight revenues, anticipates overall volumes to fall 7% or so in the current year. Amid freight weakness, Canadian Pacific Railway Limited (CP - Free Report) estimates revenue ton-miles to decline in low-single digits in 2020 from the year-ago period. Railroad volumes are likely to remain under pressure unless coronavirus concerns fade.

USMCA Agreement to Drive Growth: The United States–Mexico–Canada Agreement (“USMCA”) agreement, which came into force on Jul 1, 2020, 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. While coronavirus might be clouding the effects of the trade deal in the near term, its benefits on railroads should be evident over the longer term.

Benefits of the PSR Model: Railroads continue to benefit from the PSR model, an operating structure that reduces costs, enhances services and leads to optimal asset utilization. Amid coronavirus-led challenges, substantial reduction in operating expenses is providing a cushion to railroads. With 19.4% fall in operating expenses, Kansas City Southern’s bottom line (as reported) increased 15.6% year over year in the first nine months of 2020 despite decline in revenues, as a result of volume softness. The company expects to generate PSR savings of $95 million in 2020. Moreover, Union Pacific’s operating ratio (operating expenses, as a percentage of revenues) improved 140 basis points to 59.5% in the first nine months of 2020 with 15% reduction in operating expenses. Notably, lower the value of this key measure of efficiency, the better.

Zacks Industry Rank Indicates Gloomy Prospects

The Zacks Railroad industry, housed within the broader Zacks Transportation sector, currently carries a Zacks Industry Rank #209. This rank places it in the bottom 18% 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 2020 and 2021 EPS estimate has decreased 17.4% and 12.1% over the past year respectively.

Despite the industry’s drab near-term prospects, we will present a few stocks, which should be on your watchlist. But before that, it’s worth taking a look at the industry’s stock market performance and current valuation.

Industry Outperforms Sector & S&P 500

The Zacks Railroad industry has outperformed the broader Transportation sector and the Zacks S&P 500 composite index over the past year.

Over this period, the industry has rallied 24.2% compared with the broader sector and the S&P 500 Index’s 14.8% and 17.3% rise, respectively.

One-Year Price Performance

 

Industry’s Current Valuation

On the basis of trailing 12-month price-to-book (P/B), which is a commonly used multiple for valuing railroad stocks, the industry is currently trading at 6.88X compared with the S&P 500’s 6.18X. It is also above the sector’s P/B ratio of 4.41X.

Over the past five years, the industry has traded as high as 6.95X, as low as 2.9X and at the median of 4.86X as the chart below shows.

Price-to-Book Ratio

Price-to-Book Ratio

 

4 Railroad Stocks to Keep a Tab on

Each of the stocks mentioned below carries a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Union Pacific Corporation: Based in Omaha, NE, this company provides rail transportation services across the United States. With consistent cost-containment measures, the company expects to achieve an operating ratio of less than 60% in the current year. Over the long-term it targets an operating ratio of 55%. Additionally, coronavirus-driven rise in e-commerce demand is a boon to the company.

The Zacks Consensus Estimate for the company’s current-year earnings has been revised upward by 1.3% in the past 60 days. The same for 2021 earnings has inched up 1.6%. Shares of the company have appreciated more than19% over the past six months.

Price and Consensus: UNP


CSX: This is a leading transportation company offering rail-based freight transportation services like traditional rail service, transport of intermodal containers and trailers. Reduced costs (down 12% year over year in the first nine months of 2020) primarily due to low fuel prices and increased efficiency are aiding the company amid coronavirus-led volume weakness. The company’s commitment to reward shareholders despite adversities is encouraging. In the first nine months of 2020, it repurchased 10 million shares for $664 million.

The Zacks Consensus Estimate for the company’s 2020 and 2021 earnings has been revised upward by approximately 2% and 2.9% in the past 60 days respectively. Shares of the company have gained more than 24% over the past six months.

Price and Consensus: CSX



 

Norfolk Southern: Headquartered in Norfolk, VA, this is a major freight railroad company primarily engaged in the transportation of raw material, intermediate products and finished goods. Substantial reduction in costs (declined 16% year over year in the first nine months of 2020), thanks to the PSR model, is aiding the company’s bottom line. Additionally, a sound liquidity position is helping it better deal with the coronavirus-led challenges.

The Zacks Consensus Estimate for the company’s current-year earnings has been revised upward by 3.4% in the past 60 days. The same for 2021 earnings has moved northward by 3.5%. Shares of the company have gained more than 28% over the past six months.

Price and Consensus: NSC



 

Kansas City Southern: Based in Kansas City, MO, thisis a transportation holding company that has railroad investments in the United States, Mexico and Panama. With ramp up in economic activities, the company is seeing a gradual recovery in volumes. On the third-quarter conference call, the company stated that at the end of the third quarter of 2020, volumes were approximately 60% higher than the lows in early May. Owing to this improvement in volumes, the company estimates its 2020 adjusted earnings to slightly increase on a year-over-year basis. Previously, it expected the same to be roughly similar to the 2019 level.

The Zacks Consensus Estimate for the company’s 2020 and 2021 earnings has been revised northward by 4.4% and 2.3% in the past 60 days respectively. The stock has rallied more than 24% in the past six months.

Price and Consensus: KSU

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