Back to top

Image: Bigstock

4 Railroad Stocks to Watch Amid Industry's Rosy Near-Term Outlook

Read MoreHide Full Article

The Zacks Transportation - Rail industry is plagued by supply chain disruptions amid the prevalent pandemic. Escalating fuel prices, thanks to the Russia-Ukraine war, are an added concern for the industry. Despite these headwinds, steady improvement in freight demand, thanks to the buoyant U.S. economy, is driving growth of railroads. This makes the industry's near-term prospects appear rosy.

Companies like Union Pacific Corporation (UNP - Free Report) , CSX Corporation (CSX - Free Report) , Canadian Pacific Railway Limited (CP - Free Report) and Norfolk Southern Corporation (NSC - Free Report) are expected to thrive on the back of upbeat freight demand.

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. 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 approximately 20,000 route-miles on average.

3 Trends Shaping the Future of the Railroad Industry

Healthy Freight Demand: Freight demand continues to be strong in 2022 despite softening from the 2021 levels due to a shift in consumer spending from goods to services as pandemic fears fade, and a deceleration in inventory restocking by businesses. While the Cass Freight Index for March slowed down from the 3.6% year-over-year growth in February, it still improved 0.6%. Moreover, the index rose 2.7% from February. With steady freight demand, railroads are benefiting from higher volumes and pricing gains. The upbeat freight environment is expected to continue in the near term as the U.S. economy remains buoyant.

Supply Chain Disruptions: Persistent supply chain disruptions, including labor and equipment shortages, are hurting railroad volumes in some segments, especially the intermodal unit. The Association of American Railroads’ latest rail traffic data shows that U.S. intermodal volumes have declined 7% year over year in the first 16 weeks of 2022. Amid the prevalent pandemic, supply chain disruptions are likely to persist for a while now, thus denting intermodal volumes.

Escalating Fuel Prices: With fuel expenses being a major input cost for transportation companies, escalating fuel prices, thanks to the Russia-Ukraine war, pose a threat to railroad companies’ bottom line. Amid coronavirus-related uncertainties, rising fuel prices might further impede the growth of railroad companies.

Zacks Industry Rank Indicates Bright Prospects

The Zacks Railroad industry, housed within the broader Zacks Transportation sector, currently carries a Zacks Industry Rank #97. This rank places it in the top 38% 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, implies encouraging near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperform the bottom 50% by a factor of more than 2 to 1.

The industry’s position in the top 50% of the Zacks-ranked industries is a result of a positive earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are gradually gaining confidence in this group’s earnings growth potential. The industry’s earnings estimate has been revised upward by 2% over the past year.

Given the bullish near-term prospects of the industry, we will present a few noteworthy stocks that you may want to hold in your portfolio. But it’s worth taking a look at the industry’s shareholder returns and its current valuation first.

Industry Outperforms Sector, Flat vs S&P 500

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

Over this period, the industry and S&P 500 Index have dipped 0.5% each, compared with the broader sector’s decline of 12.6%.

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 7.59X compared with the S&P 500’s 6.18X. It is also above the sector’s P/B ratio of 4.77X.

Over the past five years, the industry has traded as high as 10.86X, as low as 5.69X and at the median of 8.06X 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: Based in Omaha, NE, Union Pacific provides rail transportation services across the United States.

Higher volumes and pricing are fueling Union Pacific’s growth. Higher revenues are leading to an improvement in UNP’s operating ratio (operating expenses as percentage of revenues). The metric improved to 59.4% in the first quarter of 2022 from 60.1% in the year-ago quarter, despite being hurt to the tune of 80 basis points by higher fuel prices.  Notably, lower the value of the metric, the better. The Zacks Consensus Estimate for the company’s 2022 earnings has been revised upward by 1.7% in the past 90 days.

Price and Consensus: UNP

 

CSX: Based out of Jacksonville, FL, CSX offers rail-based freight transportation services like traditional rail service, transport of intermodal containers and trailers, besides rail-to-truck transfers.

Amid strong freight demand, higher freight rates are driving CSX’s top line. Expecting the demand environment to sustain, management anticipates double-digit growth in the operating income and revenues for 2022 from the respective year-ago reported figures. High export coal prices and fuel surcharge revenues are expected to bolster the top line in the near term. The Zacks Consensus Estimate for CSX’s 2022 earnings has been revised northward by 1.7% in the past 90 days.

Price and Consensus: CSX

 

Canadian Pacific: Headquartered in Calgary, Canada, Canadian Pacific operates a transcontinental railway network in Canada and the United States.

Canadian Pacific’s buyout of Kansas City Southern last December is expected to drive its growth. The company is benefiting from higher freight rates owing to strong freight market conditions. CP’s commitment to reward its shareholders is encouraging. During the first quarter of 2022, it paid dividends worth $177 million, up 39.4% year over year. The Zacks Consensus Estimate for the company’s 2022 earnings has been revised upward by 2 cents in the past 30 days.

Price and Consensus: CP

 

Norfolk Southern: Headquartered in Atlanta, GA, Norfolk Southern is a major freight railroad company, primarily engaged in the transportation of raw material, intermediate products and finished goods.

Norfolk Southern’s top line is being driven higher revenues across all segments. Higher pricing is driving segmental revenues. Given its sound financial health, the company has been committed to rewarding its shareholders. During the first quarter, NSC paid dividends worth $297 million, up 19.3% year over year. It repurchased and retired common stock worth $600 million in the quarter compared with $591 million a year ago. The Zacks Consensus Estimate for the company’s 2022 earnings has been revised upward by 5 cents in the past 90 days.

Price and Consensus: NSC