Just about everyone is familiar with the popular game Monopoly. You know how it goes: buy and accumulate properties, build houses, convert them to hotels, rule the board, force people into foreclosure … and eventually win the game.
Of course, one of the most notable parts of Monopoly is the railroads. Buy them all, and you truly do have a monopoly (and great returns) — just like that old railroad tycoon Cornelius Vanderbilt.
Freight still moves around the U.S. via railroad, as anyone who has had to spend five minutes in a car desperately scanning for the caboose can tell you. Rail lines trace backbones and paths all around the country to move the freight, and the industry itself is a bit of a litmus test for the economy. When times are good, it’s time to own railroads, while easing off is warranted when it goes the other way.
But in real life, unless you are one of those railroad barons from the Gilded Age, you can’t necessarily buy up stock in enough railroad companies to create the monopoly, so investors have to be a little discerning. Sometimes you land on the square and pass; sometimes you buy. But which squares … er, railroads … are worth buying? Let’s take a look:
Our first stop is at CSX (NYSE:CSX), a Jacksonville, Fla.-based rail transportation and intermodal transport powerhouse. CSX runs just more than 21,000 miles of track in 23 states east of the Mississippi River and the Canadian provinces of Ontario and Quebec. CSX sports a market cap of just over $23 billion and revenues of $12 billion.
If you add short-term investments to CSX’s cash on hand, the company sits on more than $1 billion, and with a cash flow of $3.2 billion, the company is well-positioned for either organic or purchased growth. With a 16% profit margin and a respectable 2.5% dividend yield, you might think the company would get big love from the market, but you’d be wrong — CSX has traded down about 5% in the past year.
In its Q2 report from mid-July, revenues failed to grow after four straight quarters of improvement, down marginally year-over-year to $3.01 billion, and slightly missing estimates. But turning a frown upside down, high margins helped earnings beet the Street, with earnings per share of 49 cents representing more than 6% growth.
Trailing and forward price-to-earnings ratios of 12 and 10.5 are as attractive as you can find in the sector. Just ask billionaire Jim Simons, whose Renaissance Technologies owned 2.2 million CSX shares at the end of March. Or Jeffrey Vinik, whose Vinik Asset Management finished the quarter with 2 million shares. Either they expect returns, or they’ve lost their touch. I’ll stick with the former and take this first railroad off the board.
Next, we land on Norfolk Southern (NYSE:NSC) — a Norfolk, Va., railroad operation servicing nearly 20,000 miles of track primarily in the Southeast, East and Midwest. NSC also has a market cap of $23 billion, with slightly lower revenues of just more than $11 billion.
Also like CSX, Norfolk Southern is sitting on a mountain of cash flow — in NSC’s case, just more than $3 billion. Earnings also are growing along nicely, and its 17% profit margin is about 2 percentage points higher than CSX.
Second-quarter results were solid if not spectacular. Revenues were up slightly, but a decline in major expenses resulted in margin expansion. EPS were slightly up and beat expectations by a comfortable margin. Ho-hum, but cha-ching.
NSC has performed a little better than CSX in the past year, trading roughly flat, but it looks almost the same on paper. Norfolk Southern trades at 12.5 times trailing 12-month earnings and 11 times forward earnings, and it too yields about 2.5%. All that sounds good to me, as do the margins. Sign me up for my second railroad.
Kansas City Southern
Kansas City Southern (NYSE:KSU) is different from both of our first two railroads in a number of ways.
First off, KSU is a bit smaller, with a market cap of just less than $8 billion, and it brings in roughly $2 billion in revenues. Kansas City Southern also occupies a different part of the country — primarily the central and south central United States, northeastern and central Mexico and the port cities of Lazaro Cardenas, Tampico and Veracruz.
One thing that’s not great: KSU’s dividend yield stands at a fairly paltry 1.1%. Of course, KSU just started paying a dividend in 2011 — it did not declare any cash dividends on its common stock during the prior five years because of a prohibition of stock payouys in its bank credit agreements. Just some food for thought. However, with the restrictions lifted, KSU can hopefully start to generate increasing dividends.
A cash stash of $105 million and cash flow of just over $600 million should support milder dividend increases — but if history repeats itself, recent large outlays into capital expenditures might cut into the dividend concept.
KSU actually has had a great run, trampling the market with 25% gains in the past year. Profits and revenues continued to grow at a great clip in Q2, and earnings are expected to increase in the high teens for the next couple years — and that’s reflected in its somewhat loftier P/E’s. So, while the income aspect isn’t as solid, this might be the little growth engine that could.
Canadian National Railway
Canadian National Railway (NYSE:CNI) boasts the biggest range of these railways, managing 20,000 miles of rail operations connecting three coasts: the Atlantic, the Pacific and the Gulf of Mexico. It’s also the largest as measured by market cap, at $37 billion.
Revenues of $9.5 billion are a bit smaller than CSX and NSC, but CNI also sports a huge $2 billion cash flow, and $354 million in cash on hand, so it also is in nice shape for future growth.
Canadian National really shined in its second-quarter report, growing adjusted earnings by almost 20% to comfortably beat estimates, thanks in part to revenues that grew by 13% — and CNI has been able to consistently put up increases in both these areas for three years. Best of all, the company also upgraded its guidance of adjusted EPS growth, from 10% to 15%.
CNI has gained about 20% in the past year, with new highs being set on a nearly weekly basis. The company’s yield isn’t spectacular, at 1.7%, but Canadian National at least has been trying to keep up, growing its payout roughly 80% in the past five years.
CNI seems like a winner to me. Consistent growth, increasing dividend — and it trades at a decent 14 times future earnings? Count me in.
Wait a minute! It appears that at the end of the game, I’ve got myself four railroads.
I guess that makes me bullish on the sector. Just like ol’ Cornelius.
Marc Bastow is an Assistant Editor at InvestorPlace.com. As of this writing he did not hold a position in any of the aforementioned securities.