Investing in railroads is “an all-in wager on the economic future of the United States,” Warren Buffett said on the day his Berkshire Hathaway (NYSE:BRK.A) sunk $34 billion into Burlington Northern Santa Fe railroad. “I love these bets.”
Particularly when they pay off big. Last month, Berkshire Hathaway announced that it took a $1 billion payout from BNSF in the first quarter, which means the railroad has rewarded Buffet’s wager by paying $2.25 billion in his first 13 months of ownership, according to Bloomberg.
The rewards aren’t limited to Burlington Northern. A rebounding economy is driving growth in the railroad sector, particularly in intermodal and container volume, according to the Association of American Railroads.
Unseasonably warm weather has depressed coal shipments, which account for about one-third of freight-rail volume. But a research note from Deutche Bank Securities on Thursday suggested that investors might be overreacting to the coal slump.
That news triggered a rally in the sector on Thursday. It makes sense: Strong motor-vehicle and auto-parts shipments, as well as petroleum and chemical-tanker growth, are making up for some of the lost coal volume.
Expect freight railroads such as Burlington Northern, Union Pacific, Canadian Pacific (NYSE:UP), and Canadian National Railway (NYSE:CNI) to see increased oil shipments from Western Canada. The Obama administration in late January rejected TransCanada’s (NYSE:TRP) plan to build the Keystone XL pipeline, saying freight railroads could handle the volume with “modest expansion.”
More positive signs: Freight railroads plan to spend some $13 billion this year to expand and upgrade their infrastructure. And with Congress poised to slash funding for Amtrak passenger service, Class I freight railroads are poised to get back into the business of moving people as well as freight.
Warren Buffett also loves trains because of their fuel efficiency. A train can move one ton of freight 484 miles on a single gallon of diesel fuel. One freight train also can carry the load of 280 trucks. While the sector is vulnerable to potential obstacles such as a downturn in the economy or increased regulation, it’s built to survive adversity better than other transport modes such as trucking or air freight.
What does this mean for investors? Despite the temporary slump in coal shipments, freight railroads are rebounding in lockstep with the economy. Here are four railroad stocks that deserve a closer look:
Union Pacific (NYSE:UNP) is well-positioned to gain from Obama’s rejection of the Keystone XL pipeline. That volume growth in oil and chemicals is likely to offset some of the lost coal volume. With a market cap of $54.3 billion, UNP is trading around $113 — up more than 5% on Thursday. The stock has a price-to-earnings growth (PEG) ratio of 0.9, indicating that it may be slightly undervalued. It has a one-year return of 24% and a current dividend yield of nearly 2%.
Kansas City Southern
Kansas City Southern (NYSE:KSU) benefits from growth in intermodal traffic as more shippers move truckloads by rail. It also benefits from its Mexico and cross-border operations — particularly since it’s the only U.S. Class I railroad to own track both inside and outside Mexico. With a market cap of $8 billion, KSU is trading near $73.50 — also up 5% on Thursday. The stock has a PEG ratio of 1.2, indicating that it may be slightly overvalued. KSU does not pay a dividend, but its one-year return is an attractive 43%.
There’s significant value to Norfolk Southern (NYSE:NSC) if you look past the short-term coal slump. The railroad is betting big on intermodal growth with a new terminal near Birmingham, Ala., that it began constructing last year. With a market cap of $22.6 billion, NSC is trading around $68.50 — up 5.5% on Thursday. The stock has a PEG ratio of 0.9 and a current dividend yield of 2.6%. Its one-year return is nearly 6%.
Last May, CSX (NYSE:CSX) approved a 3-for-1 stock split, a $2 billion share buyback program and a 38% increase in its dividend. The improving economy has helped CSX, though you can expect some short-term fallout from last week’s massive derailment in Abbeville County, S.C., that caused the evacuation of 50 residents and cleanup of methanol, a potentially hazardous chemical. With a market cap of $23 billion, the stock is trading just under $22, up 8.5% on Thursday. The stock has a PEG ratio of 0.8, indicating that it may be undervalued, with a current dividend yield of 2.2%. CSX’s one-year return is -11%, but it’s well-positioned to bounce back this year.
As of this writing, Susan J. Aluise did not hold a position in any of the aforementioned stocks.