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4 Railroad Stocks to Watch Amid Coronavirus-Led Volume Woes

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The Zacks Transportation - Rail industry is benefiting from robust intermodal volumes owing to the coronavirus-triggered rise in e-commerce demand. With an uptick in economic activities, carload volumes have improved from the lows in mid-2020 but are yet to fully bounce back. This makes the railroad industry’s near-term prospects dull.

Amid coronavirus-induced adversities, benefits of the precision scheduled railroading (“PSR”) model, primarily in the form of reduced costs, is providing a cushion to railroads. In this regard, some notable players are Union Pacific Corporation (UNP - Free Report) , Norfolk Southern Corporation (NSC - Free Report) , Canadian Pacific Railway Limited (CP - Free Report) and Kansas City Southern (KSU - Free Report) .

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

Strong Intermodal Volumes: Railroads are experiencing robust intermodal volumes, thanks to the pandemic-driven rise in e-commerce demand. For instance, CSX Corporation’s (CSX - Free Report) intermodal volumes rose 11% year over year in the fourth quarter of 2020, which in turn led to 6% rise in intermodal revenues. Canadian National Railway Company’s (CNI - Free Report) intermodal volumes jumped 15% in the fourth quarter and led to 12% increase in segmental revenues. Per the Association of American Railroads’ (“AAR”) latest rail traffic report, total U.S. intermodal volumes rose 13.2% year over year in the first three months of 2021.Market watchers predict a continued increase in intermodal volumes in 2021 owing to consumer demand for goods and replenishment of inventories. This should continue to boost intermodal revenues for railroads.

Persistent Weakness in Carload Volumes: Even though railroad volumes (carloads) have improved from the pandemic-driven lows, it continues to be weak on the whole. This in turn is weighing on railroads’ top line. Evidently, Norfolk Southern’s top line declined 4.4% year over year in the fourth quarter due to low merchandise and coal volumes. AAR’s rail traffic report, dated Apr 7, shows that total U.S. carload traffic decreased 2.6% year over year in the first three months of 2021. Apart from coronavirus-led woes, adverse winter weather conditions might have weighed on volumes in the period. While carload traffic is expected to improve as the economy continues to recover and freight demand increases, with coronavirus concerns continuing there remains uncertainty at least for the near term.

Benefits of the PSR Model: The PSR model, an operating structure that reduces costs, enhances services and leads to optimal asset utilization, continues to aid railroads’ bottom line. Kansas City Southern’s bottom line inched up 3.9% year over year in the fourth quarter owing to reduced costs, courtesy of the precision-scheduled railroading model. Moreover, the company’s PSR initiatives led to operating expense savings of $96 million in 2020.The company hopes to generate additional PSR savings of $50 million in 2021. Norfolk Southern Corporation, which has its precision scheduled railroading operating plan, TOP21, in place, registered a 3.5% year-over-year improvement in the bottom line in the fourth quarter with 8% decline in operating expenses.

Zacks Industry Rank Indicates Gloomy Prospects

The Zacks Railroad industry, housed within the broader Zacks Transportation sector, currently carries a Zacks Industry Rank #189. This rank places it in the bottom 26% 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.

Despite positive earnings outlook for the constituent companies in aggregate, the industry is positioned in the bottom 50% of the Zacks-ranked industries. The group’s 2021 EPS estimate has increased by 1.4% since the end of 2020.

Against this backdrop, 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 Lags Sector But Outperforms S&P 500

While the Zacks Railroad industry has underperformed the broader Transportation sector over the past year, it has outperformed the Zacks S&P 500 composite index.

Over this period, the industry has rallied 59.3% compared with the broader sector and the S&P 500 Index’s 67.6% and 52.4% 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 7.57Xcompared with the S&P 500’s 6.99X. It is also above the sector’s P/B ratio of 5.46X.

Over the past five years, the industry has traded as high as 7.62X, as low as 3.4X and at the median of 5.01X 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.

Canadian Pacific Railway Limited: Based in Calgary, Canada, this company operates a transcontinental railway network in Canada and the United States.  It focuses on providing logistics and supply chain expertise services. Robust grain movement supports the company’s growth. Notably, the company moved 8.84 million metric tonnes (MMT) of Canadian grain and grain products in the December quarter, breaking its second-quarter 2020 record by 5.1%. Additionally, with increase in economic activities, recovery in Canadian Pacific’s automotive business is encouraging.

The Zacks Consensus Estimate for the company’s current-year earnings has been revised upward by approximately 6% in the past 90 days. Shares of the company have appreciated more than 69% in a year’s time.

Price and Consensus: CP



 

Kansas City Southern: Based in Kansas City, MO, this is a transportation holding company that has railroad investments in the United States, Mexico and Panama. Reduced costs and increased efficiency from the precision scheduled railroading model is driving the company’s bottom line. Additionally, with ramp up in economic activities, Kansas City Southern is seeing a gradual recovery in volumes, owing to which it issued an upbeat outlook for earnings per share in 2021. The company expects current-year earnings per share to be $9 or better, way above the $6.96 reported in 2020.

The Zacks Consensus Estimate for the company’s 2021 earnings has been revised northward by 7% in the past 90 days. Shares of the company have rallied approximately 92% over the past year.

Price and Consensus: KSU
 



 

Union Pacific Corporation: Based in Omaha, NE, this company provides rail transportation services across the United States. Consistent efforts to check costs are driving the company’s bottom line. Owing to cost-cutting efforts and low fuel costs, adjusted operating ratio (operating expenses as a percentage of total revenues) in 2020 improved 210 basis points to 58.5%.The company expects 2021 adjusted operating ratio to improve between 150 and 200 basis points from 2020 levels. Notably, lower the value of this efficiency measure, the better. Additionally, surge in e-commerce demand is a boon to its parcel business. The company is seeing improvement in business volumes, which is expected to drive its growth.

The Zacks Consensus Estimate for the company’s current-year earnings has been revised upward by 3% in the past 90 days. Shares of the company have gained 52% over the past year.

Price and Consensus: UNP



 

Norfolk Southern Corporation: Headquartered in Norfolk, VA, this is a major freight railroad company primarily engaged in the transportation of raw material, intermediate products and finished goods. Amid weak revenues, the company is benefiting from reduced costs (operating expenses declined 14% in 2020), thanks to the PSR model. Despite adversities, the company’s consistent measures to reward shareholders raises optimism in the stock. In 2020, the company returned $2,399 million to shareholders through a combination of dividends ($960 million) and share buybacks ($1,439 million).

The Zacks Consensus Estimate for the company’s current-year earnings has been revised upward by 6 cents in the past 90 days. Shares of the company have gained more than 76% over the past year.

Price and Consensus: NSC

 

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