Value investors looking for stable buy-and-hold stocks that offer reliable income will find a lot to love in freight railroad stocks. While the industry does face potential headwinds with declining coal volumes, the best railroad stocks are a play on the rebounding economy and the shale oil and gas boom.
Coal once was the lifeblood of freight railroads, but as energy companies turned to cleaner power generation, King Coal has been supplanted by natural gas. While the decline in coal shipments has had an impact of railroad revenues, the recent shale oil and gas boom is helping offset that lost business.
With continued delays on the Keystone XL pipeline, freight railroads have been a boon for shale oil and frac sand shipments. In 2013 alone, some 400,000 carloads of crude oil moved by rail — more than 40 times the number of carloads transported just five years earlier, according to the Association of American Railroads.
Freight railroads are facing potential regulatory headwinds in response to shippers’ complaints of poor rail service performance. It likely would draw close scrutiny from the Surface Transportation Board, which already is looking to tighten regulations to boost rail service performance.
Shippers, however, do not have a lot of alternatives. Trucking industry capacity is extremely tight and railroads can move a ton of freight 476 miles on a single gallon of diesel fuel. Railroads offer a cost effective alternative to trucks particularly in the intermodal segment — freight that is shipped in containers. That said, here are three railroad stocks to ride now:
Railroad Stocks to Buy – CSX (CSX)
YTD Performance: 12%
Dividend Yield: 2%
CSX (CSX) reported a third-quarter earnings and revenue beat after Tuesday’s market close. Profit surged nearly 11% to 51 cents a share on revenue of $3.2 billion; Wall Street had expected an EPS of 47 cents on $3.14 billion in revenue.
Crude oil and frac sand shipments drove the better than expected gains and the company is looking for double-digit growth in earnings and margins next year.
Since railroad stocks tend to be a bellwether for the economic growth, such a bullish view from CSX is good news for the economy at large.
Railroad stocks have had a wild week so far — and CSX has been at the center of the action. CSX shares soared more than 10% on rumors that Canadian Pacific Railway (CP) was eying a merger bid for CSX. Such a deal could be worth more than $60 billion, dwarfing the $26 billion Warren Buffett’s Berkshire Hathaway (BRK.B) paid for Burlington Northern Santa Fe just four years ago.
Although CP and CSX have downplayed the merger rumors, such a deal could achieve significant economies of scale and would likely set off a new wave of mergers and acquisitions among Class 1 freight railroads.
Railroad Stocks to Buy – Norfolk Southern (NSC)
YTD Performance: 13%Dividend Yield: 2.2%
Norfolk Southern (NSC) operates on nearly 22,000 miles of track in 22 states, primarily in the eastern U.S. Coal volume historically has been important to freight railroads and NSC is no exception. The company continues to face headwinds over declining coal shipments, but higher natural gas process could give King Coal a boost — and that would help NSC’s bottom line.
Norfolk Southern has done a good job of growing other business segments – most notably metals, construction and intermodal shipments. But the railroad is facing increased scrutiny over delays of Amtrak trains that run over its tracks in northern Ohio. The Surface Transportation Board wants to know why Amtrak service on two lines that come through Cleveland has been on time less than 40% of the time over the past 12 months.
NSC could be fined over the delays, but the railroad is investing in infrastructure and hiring more personnel to help resolve the performance problems. In July, NSC’s second-quarter earnings beat Wall Street expectations with an EPS of $1.79 on revenue of $3.042 billion – analysts had been looking for $1.74 on a top line of $3.027 billion. On Oct. 22, NSC is expected to report earnings of $1.79 a share on $3.1 billion in revenue.
Union Pacific (UNP)
YTD Performance: 17%
Current Dividend Yield: 2%
With some 31,800 route miles in 23 states, UNP is the nation’s largest freight railroad — and the head-to-head competitor with Warren Buffet’s Burlington Northern Santa Fe throughout the Midwest and Western U.S. UNP’s operating margin of nearly 35% is the best in the freight railroad sector.
UNP is coming off a strong second quarter, led by increases in agricultural products, as well as strong gains in its intermodal and industrial products volume. Intermodal and construction products recorded double-digit gains and Union Pacific is optimistic about growth in its industrial products volume — particularly frac sand. On Oct. 23, UNP is expected to report earnings of $1.52 a share on $6.09 billion in revenue.
President and CEO Jack Koraleski has had a very difficult act to follow, succeeding James Young, who passed away from pancreatic cancer in February. Young, an iconic figure for UNP and the railroad industry as a whole, had been on leave from the company for nearly two years, but had been providing leadership support for the company.
As of this writing, Susan J. Aluise did not hold a position in any of the aforementioned securities.
