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3 Railroad Stocks to Overcome Industry's Near-Term Challenges

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The Zacks Transportation - Rail industry is benefiting from significantly improved volumes, thanks to an uptick in economic activities. However, weakness in volumes in certain commodity groups is a near-term challenge for the industry. High fuel expenses due to rising fuel prices further dull the prospects of the railroad industry.

Despite adversities, companies like Union Pacific Corporation (UNP - Free Report) , CSX Corporation (CSX - Free Report) and Norfolk Southern Corporation (NSC - Free Report) are expected to gain on expectations of continued improvement in volumes as the economy gathers momentum.

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. These companies focus on providing logistics and supply chain expertise services. 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. A few companies offer service to multiple production and distribution facilities. Besides owning locomotives, some of these companies have an equipment of leased locomotives, railcars etc. These companies have an extended network, spanning across approximately 20,000 route-miles on average.

3 Trends Shaping the Future of the Railroad Industry

Recovering Volumes: With ramp-up in economic activities and improved freight demand, railroad volumes have recovered significantly from the coronavirus-led slump, as reflected in the second-quarter performances of some key industry participants. CSX’s total volumes increased 27% year over year in the second quarter with growth across all segments. Union Pacific’s business volumes, measured by total revenue carloads, increased 22% year over year driven by higher shipments across all its units. The Association of American Railroads’ (“AAR”) latest rail traffic report shows that total U.S. rail traffic (carloads and intermodal units) rose 12% in the first 31 weeks of 2021 from the same period last year. Railroad volumes are expected to continue the upward trend in the near term as freight demand strengthens and the economy improves further.

Certain Segments Continue to Exhibit Weakness: Railroad volumes in certain segments continue to exhibit substantial weakness. For instance, automotive shipments are being hurt by semiconductor shortages, while lower grain exports are weighing on grain volumes. Norfolk Southern’s management expects coal market volatility to persist with volumes likely to decline year over year in 2021 due to maintenance outages. It also anticipates automotive shipments to decline year over year in the September quarter due to planned production downtime pertaining to the semiconductor shortage. Union Pacific is experiencing softness in automotive volumes, while low crude shipments are weighing on Kansas City Southern’s (KSU - Free Report) crude oil revenues and revenue per carload. Persistently low volumes in these segments might hurt railroad’s top line.

Rising Fuel Prices Pose a Threat: Since fuel expenses comprise a substantial input cost for transportation companies, rise in fuel prices pose a threat to railroad’s bottom line. For Union Pacific expenses on fuel increased 101% year over year in the second quarter, inducing a 17% rise in operating expenses. Higher fuel prices hurt the company’s second-quarter operating ratio (operating expenses as a percentage of revenues) to the tune of 210 basis points. For Norfolk Southern, operating expenses rose 11% year over year in the second quarter primarily due to a 124% surge in fuel costs. Amid lingering effects of coronavirus, rising fuel prices may further impede growth of railroad companies.

Zacks Industry Rank Indicates Gloomy Prospects

The Zacks Railroad industry, housed within the broader Zacks Transportation sector, currently carries a Zacks Industry Rank #236. This rank places it in the bottom 7% 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 is positioned in the bottom 50% of the Zacks-ranked industries. The group’s 2021 EPS estimate however, has increased by 7.5% over the past year.

Against this backdrop, we will present a few noteworthy stocks. But before that, it’s worth taking a look at the industry’s stock market performance and current valuation.

Industry Lags Sector & S&P 500

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

Over this period, the industry has risen 19.9% compared with the broader sector and the S&P 500 Index’s 22% and 34.2% increase, 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 10.27X compared with the S&P 500’s 7.26X. It is also above the sector’s P/B ratio of 6.74X.

Over the past five years, the industry has traded as high as 10.93X, as low as 5.57X and at the median of 7.7X as the chart below shows.

Price-to-Book Ratio

 

Price-to-Book Ratio

3 Railroad Stocks to Keep a Tab on

Union Pacific Corporation: Based in Omaha, NE, this company provides rail transportation services across the United States.

The company’s top line is being aided by improved volumes. It expects volumes to increase 7% year over year in 2021. Strong free cash flow generation capacity supports Union Pacific’s measures to reward its shareholders. The company carries a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

The Zacks Consensus Estimate for the company’s current-year earnings has been revised upward by 4.6% in the past 60 days. Shares of the company have rallied 17.5% over the past year.

Price and Consensus: UNP

 

CSX Corporation: Based in Jacksonville, FL, the company offers rail-based freight transportation services like traditional rail service, transport of intermodal containers and trailers apart from rail-to- truck transfers.

The company, carrying a Zacks Rank #3 (Hold), is seeing higher volumes across all its segments. Anticipating volumes to continue to improve, it hopes to achieve double-digit revenue growth in 2021. CSX’s acquisition of Quality Carriers enables the company to broaden its network and gain access to new products, markets and regions. CSX expects the transaction to boost its revenues by approximately 6% on an annualized basis.

The Zacks Consensus Estimate for the company’s current-year earnings has been revised upward by approximately 5% in the past 60 days. Shares of the company have rallied 35.5% in a year’s time.

Price and Consensus: CSX

 

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.

Improvement in domestic shipments is driving growth at Norfolk Southern. In the second quarter, domestic shipments increased not only from the year-ago period but also the pre-coronavirus level. The company’s measures to reward its shareholders raise optimism in the stock. So far this year, the company has increased its dividend payout twice.

The Zacks Consensus Estimate for the company’s current-year earnings has been revised upward by 4.6% in the past 60 days. Shares of the company, carrying a Zacks Rank #3, have gained around 29% in a year’s time.

Price and Consensus: NSC