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Sunny Prospects for Railroads' Near Term Despite Soft Freight
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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:
The railroad industry was severely plagued by low freight demand all of last year due to the U.S.-China trade tensions. With the signing of the phase one trade deal in January, there was some hope for a rebound in the freight scene this year. However, supply-chain disruptions caused by the coronavirus outbreak may delay the freight turnaround. The health peril has perhaps already started taking its toll on the railroad industry. Per the Association of American Railroads (AAR), for the week ending Mar 7, U.S. intermodal volumes were down 14.1% from the same period last year with the number of ships arriving at West Coast ports from Asia declining substantially.
Due to the capital intensive nature of the business, these companies usually carry a lot of debt burden. For instance, Union Pacific Corporation (UNP - Free Report) has a long-term debt-to-equity ratio (measured as a percentage) of more than 100. CSX Corporation (CSX - Free Report) and Canadian Pacific Railway Limited (CP - Free Report) too have a debt-to-equity ratio of over 100%. 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.
Freight railroads aim to boost profits by improving operating ratio (operating expenses as a percentage of revenues), a key measure of efficiency. To this end, almost all of the Class I railroads including CSX, Union Pacific and Norfolk Southern Corporation (NSC - Free Report) transitioned to the precision scheduled railroading model, an operating structure that reduces costs, enhances services and leads to optimal asset utilization. With increased efficiency and reduced costs, these railroad players showed a consistent improvement in the operating ratio. While CSX’s operating ratio improved to 58.4% in 2019 from 60.3% a year ago, Union Pacific’s operating ratio improved 210 basis points to 60.6%. Lower the value of this key metric, the better. Union Pacific expects an operating ratio of approximately 59% in the current year. Meanwhile, Norfolk Southern’s operating ratio bettered to 64.7% in 2019 from 65.4% a year ago. The company aims to achieve an operating ratio of 60% in 2021. Cost-cutting measures apart, low fuel prices are a boon to the industry as fuel expenses account for a substantial input cost for railroads.
Zacks Industry Rank Indicates Bright Prospects
The Zacks Railroad industry housed within the broader Zacks Transportation sector currently carries a Zacks Industry Rank #110. This rank places it at the top 43% 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 solid 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.
Amid the optimism, we will present a few noteworthy stocks. But before that, it’s worth taking a look at the industry’s shareholder returns and current valuation.
Industry Outperforms Sector But Underperforms S&P 500
While the Zacks Rail industry, the broader Transportation sector and the Zacks S&P 500 composite index have all declined over the past year, the Zacks Rail industry has outperformed the broader sector but underperformed the S&P 500 composite index.
Over this period, the industry has declined 23.6% compared with the broader sector and the S&P 500 Index’s depreciation of 31.1% and 16.5%, respectively.
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 3.83X compared with the S&P 500’s 3.21X. It is also above the sector’s P/B ratio of 2.02X.
Over the past five years, the industry has traded as high as 5.85X, as low as 2.21X and at the median of 4.41X as the chart below shows.
Price-to-Book Ratio
Price-to-Book Ratio
Bottom Line
Stringent cost-reduction efforts, courtesy of the precision scheduled railroading model, are aiding the railroads’ bottom line. Significant decline in crude oil prices since the beginning of this year should further drive the bottom line. With these factors in place, the railroads seem well equipped to brave the challenges posed by the weak freight scenario at least in the near term.
Kansas City Southern is a transportation holding company based in Kansas City, MO. The Zacks Consensus Estimate for this Zacks #3 Ranked company’s current-year EPS has been revised upward by approximately 1% in the past 90 days. It also has a stellar earnings history, having trumped the Zacks Consensus Estimate in each of the trailing four quarters, the average being 4.7%. The company has an expected earnings per share growth rate of 16.2% for the current year, higher than the industry’s 8.6%.
Price and Consensus: KSU
Norfolk Southern Corporation is a company primarily engaged in the rail transportation of raw material, intermediate products and finished goods, mainly in Southeast, East and Midwest United States. The company has an impressive earnings record, having outperformed the Zacks Consensus Estimate in three of the trailing four quarters (earnings miss in one), the average beat being 6.2%. The company has an expected earnings per share growth of 11.8% for 2021 compared with the industry’s 10.6%.
Price and Consensus: NSC
Canadian Pacific Railway Limited operates a transcontinental railway network in Canada and the United States. This company also has an encouraging earnings history, having outperformed the Zacks Consensus Estimate in three of the trailing four quarters (earnings miss in one). It has an expected earnings per share growth rate of 10.8% for the current year.
Price and Consensus: CP
Canadian National Railway Company (CNI - Free Report) is engaged in the rail and related transportation business. The company’s earnings surpassed the Zacks Consensus Estimate in three of the preceding four quarters (earnings miss in one), the average beat being 2.2%. It has an expected earnings per share growth rate of 11.8% for the next year.
Price and Consensus: CNI
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Sunny Prospects for Railroads' Near Term Despite Soft Freight
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:
The railroad industry was severely plagued by low freight demand all of last year due to the U.S.-China trade tensions. With the signing of the phase one trade deal in January, there was some hope for a rebound in the freight scene this year. However, supply-chain disruptions caused by the coronavirus outbreak may delay the freight turnaround. The health peril has perhaps already started taking its toll on the railroad industry. Per the Association of American Railroads (AAR), for the week ending Mar 7, U.S. intermodal volumes were down 14.1% from the same period last year with the number of ships arriving at West Coast ports from Asia declining substantially.
Due to the capital intensive nature of the business, these companies usually carry a lot of debt burden. For instance, Union Pacific Corporation (UNP - Free Report) has a long-term debt-to-equity ratio (measured as a percentage) of more than 100. CSX Corporation (CSX - Free Report) and Canadian Pacific Railway Limited (CP - Free Report) too have a debt-to-equity ratio of over 100%. 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.
Freight railroads aim to boost profits by improving operating ratio (operating expenses as a percentage of revenues), a key measure of efficiency. To this end, almost all of the Class I railroads including CSX, Union Pacific and Norfolk Southern Corporation (NSC - Free Report) transitioned to the precision scheduled railroading model, an operating structure that reduces costs, enhances services and leads to optimal asset utilization. With increased efficiency and reduced costs, these railroad players showed a consistent improvement in the operating ratio. While CSX’s operating ratio improved to 58.4% in 2019 from 60.3% a year ago, Union Pacific’s operating ratio improved 210 basis points to 60.6%. Lower the value of this key metric, the better. Union Pacific expects an operating ratio of approximately 59% in the current year. Meanwhile, Norfolk Southern’s operating ratio bettered to 64.7% in 2019 from 65.4% a year ago. The company aims to achieve an operating ratio of 60% in 2021. Cost-cutting measures apart, low fuel prices are a boon to the industry as fuel expenses account for a substantial input cost for railroads.
Zacks Industry Rank Indicates Bright Prospects
The Zacks Railroad industry housed within the broader Zacks Transportation sector currently carries a Zacks Industry Rank #110. This rank places it at the top 43% 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 solid 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.
Amid the optimism, we will present a few noteworthy stocks. But before that, it’s worth taking a look at the industry’s shareholder returns and current valuation.
Industry Outperforms Sector But Underperforms S&P 500
While the Zacks Rail industry, the broader Transportation sector and the Zacks S&P 500 composite index have all declined over the past year, the Zacks Rail industry has outperformed the broader sector but underperformed the S&P 500 composite index.
Over this period, the industry has declined 23.6% compared with the broader sector and the S&P 500 Index’s depreciation of 31.1% and 16.5%, respectively.
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 3.83X compared with the S&P 500’s 3.21X. It is also above the sector’s P/B ratio of 2.02X.
Over the past five years, the industry has traded as high as 5.85X, as low as 2.21X and at the median of 4.41X as the chart below shows.
Price-to-Book Ratio
Price-to-Book Ratio
Bottom Line
Stringent cost-reduction efforts, courtesy of the precision scheduled railroading model, are aiding the railroads’ bottom line. Significant decline in crude oil prices since the beginning of this year should further drive the bottom line. With these factors in place, the railroads seem well equipped to brave the challenges posed by the weak freight scenario at least in the near term.
Below we present four stocks with a Zacks Rank #3 (Hold) that investors may currently hold onto. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
Kansas City Southern is a transportation holding company based in Kansas City, MO. The Zacks Consensus Estimate for this Zacks #3 Ranked company’s current-year EPS has been revised upward by approximately 1% in the past 90 days. It also has a stellar earnings history, having trumped the Zacks Consensus Estimate in each of the trailing four quarters, the average being 4.7%. The company has an expected earnings per share growth rate of 16.2% for the current year, higher than the industry’s 8.6%.
Price and Consensus: KSU
Norfolk Southern Corporation is a company primarily engaged in the rail transportation of raw material, intermediate products and finished goods, mainly in Southeast, East and Midwest United States. The company has an impressive earnings record, having outperformed the Zacks Consensus Estimate in three of the trailing four quarters (earnings miss in one), the average beat being 6.2%. The company has an expected earnings per share growth of 11.8% for 2021 compared with the industry’s 10.6%.
Price and Consensus: NSC
Canadian Pacific Railway Limited operates a transcontinental railway network in Canada and the United States. This company also has an encouraging earnings history, having outperformed the Zacks Consensus Estimate in three of the trailing four quarters (earnings miss in one). It has an expected earnings per share growth rate of 10.8% for the current year.
Price and Consensus: CP
Canadian National Railway Company (CNI - Free Report) is engaged in the rail and related transportation business. The company’s earnings surpassed the Zacks Consensus Estimate in three of the preceding four quarters (earnings miss in one), the average beat being 2.2%. It has an expected earnings per share growth rate of 11.8% for the next year.
Price and Consensus: CNI
Looking for Stocks with Skyrocketing Upside?
Zacks has just released a Special Report on the booming investment opportunities of legal marijuana.
Ignited by new referendums and legislation, this industry is expected to blast from an already robust $6.7 billion to $20.2 billion in 2021. Early investors stand to make a killing, but you have to be ready to act and know just where to look.
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