As oil prices have cratered, so have share prices for the various companies involved in the energy industry. From sand and drilling equipment suppliers to firms actually prospecting for oil, the crash has been pretty dramatic.
Broad energy-related funds like the Energy Select Sector SPDR ETF (NYSEARCA:XLE) are down about 26% from their peaks. And with many analysts now dialing back their price targets for crude oil in 2015, share prices for various energy stocks could be down for a bit longer.
But as investors have sold everything related to energy, some bargains are beginning to form. One of the biggest could be railroad stocks.
The sector is more than just a crude-by-rail play. Even with lower overall oil prices, railroad stocks should continue to churn out hefty profits and dividends for investors. And now longer-term portfolios can take advantage of the fire sale in railroad stocks.
Crude-By-Rail Still Just A Sliver
The big story for the railroad stocks over the last few years has been the growth in crude-by-rail volumes. As American and Canadian shale drillers have fracked in new exotic locals, the lack of pipeline infrastructure had many turning to railroads as way to get their crude oil to market.
Refiners loved the flexibility of being able to pick and choose which crude they bought and helped increase their juicy margins.
As such, from 2008 to the end of the last year, crude-by-rail shipments surged from 9,500 tanker carloads to more than 435,000 — a gain of nearly 4,000% in a very short time. That growth has helped propel the traditionally boring and staid railroad stocks to new highs.
Unfortunately, the reverse has also played out.
With prices for WTI crude oil falling by the wayside, many investors have fled the railroads. After all, reduced drilling means reduced crude-by-rail volumes and ultimately smaller profits at the railroad stocks. However, this is a case of investors getting the situation totally wrong.
They’ll be just fine.
Despite their growth, crude-by-rail volumes only makes up a small percentage of the railroad stocks’ total profits. Those 435,000 tankers of crude oil only make up about 2% of all the carloads worth of freight that the major railroads deliver. That’s really just a pittance.
The vast bulk of shipped freight is coming from other industrial and consumer activity. With the economy finally swimming along, freight volumes for non-crude oil related shipments have also begun to rise steadily and capacity among the railroads remains tight.
And in terms of crude-by-rail, the railroads are still the only game in town in many production areas.
In the Bakken shale, more than 59% of the 1.2 million barrels of oil produced each day travels via rail. That’s not going to stop. Lower oil prices will reduce new drilling, but it won’t turn the spigot off at wells that are already tapped. It’s very expensive to shut off a well. Meaning, unless oil plunges really low, the Bakken and the railroad stocks will keep churning out crude-by-rail.
One more thing powering the railroad stocks — that lower price-per-barrel is an added boost to operating costs.
Railroads spend a lot at the pump in order to keep chugging — millions of dollars per quarter. With oil prices falling by more than 50% over the last few months, that’s a huge cost savings for railroad stocks. That cost savings will translate into better margins and earnings even if they lose some business as energy firms stop drilling.
According to some analysts, the net effect will actually be in favor of the railroads by a wide margin.
With that in mind, analysts at Credit Suisse estimate that the railroad stocks will all be higher by 20% over the next 12 months as investors realize that crude-by-rail isn’t the only game in town for the sector.
2 Railroad Stocks Bargains
Despite rising 18% over the last 12 months, CSX Corporation (NYSE:CSX) could be a great buy for investors looking for bargains among railroad stocks.
Click to EnlargeAs the largest railroad in the eastern chunk of the United States that services the Bakken, CSX actually expects that its trains carrying crude oil to rise from three trains per day to nearly five.
CEO Michael Ward said recently that the average producer that CSX services can make money with oil at $30 to $35 per barrel, so he doesn’t expect lower oil prices to impact CSX in 2015.
At the same time, CSX saw increasing coal, intermodal and merchandise shipments rise with its latest reported quarter. As these shipments have grown and capacity is tight, CSX announced new price increases for its customers.
All in all, that will allow the firm to build on its recent 15% profit increase.
Receiving about 7.5% of its revenues from crude-by-rail, Union Pacific Corporation (NYSE:UNP) has fallen about 11% from its highs as investors have abandoned the narrative.
Click to EnlargeAgain, this is an example of throwing the “baby away with the bathwater.”
UNP is the largest freight railroad in the U.S. — thanks to being founded during the Civil War. In fact, the famous Golden Spike is on a UNP line. That leaves it huge barriers to entry versus competitors.
And with the bulk of its revenue coming from intermodal freight, coal and grain shipments in the Midwest, the drop in oil prices is pretty much meaningless for UNP on a long-term basis.
UNP’s latest earnings reports have shown that fact. When it reports later this week, analysts expect all of these business lines to help UNP report a 4.1% increase in profits.
Bottom Line
While crude-by-rail shipments have been growing, they still are a relatively small part of the railroad stocks overall revenues. And yet, many investors are treating them like it’s the only game in town. That’s leaving some tasty bargains in the sector.
CSX, UNP and others — like Canadian Pacific Railway Limited (NYSE:CP) — make great buys.
As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.
