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Stocks in the railroad space have performed impressively so far this year buoyed by the improvement in the coal-related scenario. Since coal is a key revenue generating commodity for stocks in this space, any positive coal-related update is bound to lift their spirits.

In fact, improvement on the coal front is highly significant for railroads as stocks in the space had struggled over the last few years due to dwindling coal shipments. The bullishness surrounding the railroad operators is evident from a 11.3% increase witnessed in the Dow Jones U.S. Railroads Index, year to date.

Coal Revival - The Primary Catalyst Behind the Surge

The revival of coal can be made out from the impressive performances of most sector participants with respect to the commodity in the second quarter of 2017. For example, at Union Pacific Corporation (UNP - Free Report) coal revenues (freight) increased 25% while the same at CSX Corporation (CSX - Free Report) and Norfolk Southern Corporation (NSC - Free Report) improved 27% and 32%, respectively.

Currently, all these three stocks carry a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

In fact, the election of President Trump last year has been a boon for this industry. Notably, Trump’s pro-coal stance is a huge positive for the commodity which lost much of its relevance during President Obama’s tenure as a source of fuel.

Trump has been advocating the case for fossil fuels instead of renewable energy, and has raised questions regarding climate change and its expected widespread impact. Already, he has started to act on his pre-election promises and has also taken measures to repeal the Clean Power Plan. He walked out of the Paris Climate Agreement as well.

A thriving and improving economy also supports the bullish case for railroads as it implies that more goods are being transported across the United States on the rails. This improvement under the new regime is evident from the fact that the Zacks Rail industry outperformed the broader market so far this year. While the S&P 500 Index gained 11%, the industry added 12.8%.

Based on this healthy picture, we expect a surge in the usage of coal during the Trump regime. Additionally, coal volumes will be positively impacted in the event of higher industrial production.

Intermodal Shows Promise

Apart from the bullish coal-related scenario and industrial growth, improvement in intermodal volumes and pricing are also expected to boost stocks in the railroad space. In fact, things  have turned around for the better in the current year, which is a positive for the sector as intermodal continues to generate significant revenues for major U.S. railroad companies.

According to the Intermodal Association of North America, intermodal volumes improved 2% year over year in the first quarter of 2017. The scenario improved further in the second quarter with the measure rising 4.5%. In fact, this was the highest growth rate recorded in almost three years.

Financial Strength

We note that the strong balance sheets of major railroads have enabled them to engage in shareholder-friendly activities. In keeping with this trend, Kansas City Southern (KSU - Free Report) recently announced a 9.1% hike in its quarterly dividend payout to 36 cents per share. Moreover, the company announced fresh buyback plans.

Additionally, the likes of Canadian National Railway (CNI - Free Report) , Canadian Pacific Railway (CP - Free Report) and CSX Corp. have hiked their respective dividend payouts this year. In another shareholder friendly move, Norfolk Southern recently increased its full-year 2017 target pertaining to buybacks from $800 million to $1 billion.

In fact, the significant investments made by railroads to promote safety also raise optimism and indicate toward their financial well being.

Going forward, railroads are also looking to drive bottom-line growth through various cost cutting measures. To improve efficiencies, Union Pacific recently announced that it intends to trim its workforce by up to 750 employees.

Zacks Industry Rank Supports Bullish Scenario

The Zacks Industry Rank of 17 (out of 250 plus groups) carried by the Zacks Rail industry further highlights the attractiveness of railroads as an investing option on the back of the tailwinds mentioned above. Markedly, the favorable rank places the companies in the top 7% of the Zacks industries.

We put our entire 250-plus industries into two groups: the top half (i.e., industries with the best average Zacks Rank) and the bottom half (the industries with the worst average Zacks Rank).

Over the last 10 years, using a one-week rebalance, the top half beat the bottom half by a factor of more than 2 to 1.

Click here to know more: About Zacks Industry Rank

Railroads Should Grace Your Portfolio

Given the bullish sentiment surrounding railroads, we believe that it will be prudent for investors to add stocks from the space to their respective portfolios to generate handsome returns.

However, given the vastness of the railroad space, it is by no means an easy task to identify the few bright spots. Therefore, we have utilized our Zacks Stock Screener  to pinpoint such stocks. The Zacks Rank, which justifies a company’s strong fundamentals, can come in really handy.

Our Choices

Based in Montreal, Canada, Canadian National Railway Company is engaged in the rail and related transportation business. The company currently sports a Zacks Rank #1. The current-quarter Zacks Consensus Estimate for earnings has climbed 4.9% to $1.08 per share in the last month. For full-year 2017, the same moved up 4.4% to $4.06 per share in the same period.

Canadian Pacific Railway Limited, headquartered in Calgary, Canada, operates a transcontinental railway network in Canada and the United States. The company currently carries a Zacks Rank #2 (Buy) and has a Value Score of B. The current-qurter Zacks Consensus Estimate for earnings has climbed 4.8% to $2.4 per share in the last two months. For full-year 2017, the same moved up 5.5% to $9.04 per share in the same period.

Based in Kansas City, MO, Kansas CitySouthern has railroad investments in the United States, Mexico and Panama. The company currently carries a Zacks Rank #2 and has a Value Score of B. The current-quarter Zacks Consensus Estimate for earnings has climbed 1.5% to $1.36 per share in the last two months. For full-year 2017, the same moved up 1.8% to $5.18 per share the same period.

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