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Will the Bull Run Continue for Freight Railroad Stocks?

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Freight railroad is vital for domestic freight as it accounts for around 40% of the U.S. transport sector. A strong U.S. economy supports the bullishness of freight railroad operators, as it implies that more goods are being transported across the country.

The robust financial health of railroads bears testimony to the fact that the scenario has improved considerably for players in this industry, after having been battered by coal-related headwinds over the last few years. This indicates that freight railroad stocks will provide good return in the long-term.

Coal Price, Intermodal Volume Improvement Boosts Railways

The turnaround of this key industry can be attributed to an improvement in the coal-related scenario. This is because coal is considered as a key revenue-generating commodity for railroads.

On Feb 16, U.S. Energy Information Association (“EIA”) estimated that U.S. coal production for 2017 will amount to 773 million short tons (MMst), This figure is 45 MMst higher than 2016 as well as the largest year-over-year tonnage increase since 2001. The agency also stated that the coal prices across the United States rose in 2017, especially for Central Appalachian coal.

Moreover, prospects of the coal industry have brightened because of President Trump’s pro-coal stance, wherein he promised to relax emissions rules. Higher price of natural gas and improvement of coal prices in global market have also given a boost to the demand for this key commodity. As the fortunes of most railroad operators depend on coal, any positive development related to this commodity augurs well for railroads.

Improvement in intermodal volumes is also a positive for railroads. Trump’s proposed policy changes have made the overall economic outlook fairly bullish. The two pro-growth policies of Trump, namely, significant cut in corporate tax and deregulation are major catalysts to the U.S. economy.  Further, efforts of railroads to drive bottom-line growth through cost-cutting measures raise optimism in stocks from this space.

Robust AAR Data

The Association of American Railroads (“AAR”), the industry body of the class 1 freight railroad operators, reported that U.S. rail traffic (including carloads and intermodal units) stood at 534,282 for the week ended Mar 10, 2018. This reflects an increase of 1.6% year over year. Six of the 10 carload commodity groups posted an increase compared with the same week in 2017. Total combined U.S. rail traffic (including carloads and intermodal units) for the first 10 weeks of 2018 was 5,193,970, up 2% year over year.

Railroads should continue to witness an improvement pertaining to another key metric - operating ratio (operating expenses as a percentage of revenues) in 2018. The lesser the value of operating ratio, the better, as it implies that more cash is available to the company to reward shareholders through hike in dividends or share buybacks.

Over a year, the Zacks Rail Industry increased 17.5%. In comparison, stock price of five major railroad operators, Union Pacific Corp. (UNP - Free Report) , Kansas City Southern , Canadian Pacific Railway Ltd. (CP - Free Report) , CSX Corp. (CSX - Free Report)   and Norfolk Southern Corp. (NSC - Free Report) , rallied 29.1%, 21.5%, 19.9%, 18.4% and 17.2%, respectively. Each of these stocks has a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Bottom Line

Improvement in the prospects of key units like coal and intermodal has been benefiting railroads since the beginning of the year. These positives will further drive the stock price of freight railroad operators.

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