Want to Buy Railroad Stocks? Be Patient. VERY Patient.

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If you’re an investor in railroad stocks, 2015 has not been a happy year. It’s not clear when the situation will improve. But railroads are so badly beaten up that now may be a good time at least to look at them.

Want to Buy Railroad Stocks? Be Patient. VERY Patient.

Shares of the publicly traded Class 1 railroads are in an ugly bear market: down more than 30% from their 52-week highs and roughly 28% for the year. They are the biggest drags on the Dow Jones Transportation Average, down nearly 18% off its 52-week high and 16% for the year.

And that’s despite a 4%-to-7% rebound since hitting lows on Aug. 24.

History suggests a test of those lows is needed to confirm a bottom was reached. Meanwhile, railroad stocks still face some difficult headwinds.

  • The stock market is suffering its first serious correction since 2011. The Dow Jones industrials have fallen 12.8% from all-time highs, with the S&P 500 off 11.9% and the Nasdaq Composite down 13.2%.
  • The dollar is too strong — rising 7.7% this year against the euro after a 13% gain last year — and is crimping U.S. exports, especially to Europe, Japan and China. The dollar is also hurting domestic producers against foreign competition. Steel is a prime example.
  • Railroad stocks were due for a big-time pullback. They enjoyed a huge rally from the 2009 market bottom until peaking late in 2014 and early this year. Union Pacific (UNP) jumped 365% to its peak of $124.56 in February. Norfolk Southern’s (NSC) gain to its peak late in 2014 was 350%. CSX Corp. (CSX) soared 450%.
  • The rail companies’ largest customers — coal producers — are suffering because of low prices, a shift to cheaper natural gas, which is moved by pipelines, and the prospect of more stringent regulations to reduce air pollution.

railroad stocks table

Gas, at about $2.67 per million British thermal units, is down nearly 8% this year after falling nearly 32% in 2014. That’s a function of the global collapse of oil prices. The share of natural gas as a fuel for power generation has jumped from 16% in 2000 to 27% in 2014, according to a study this summer by the Association of American Railroads.

Coal prices have come down in response — about 10% this year, no matter where the coal is produced. Mines have shut down. So the demand for rail services to get the coal to customers has fallen.

In the second quarter, coal generated about 13% of total revenue for Union Pacific, down from 17% a year earlier. It was 16.7% of revenue for Norfolk Southern, down from 22% a year ago, and 21% of revenue for CSX Corp, down from 23% in the 2014 second quarter.

Union Pacific and Burlington Northern Santa Fe, now owned by Berkshire Hathaway (BRK.B), are also getting hurt by lower crude-oil shipments from North Dakota’s Bakken field. The Bakken lacks the pipeline networks to transport crude.

Again, the problem is price. Light sweet crude, which settled Monday at $44.43 a barrel, is off 25% so far in the third quarter and 17% for the year. And that’s after a 46% decline in 2014.

The railroads are profitable, and railroad stocks have been whacked as much because of global market woes as anything they’re doing. Moreover, the railroads’ coal-moving infrastructure still has value because coal won’t be replaced entirely any time soon. Moreover, the oil-price collapse has cut railroads’ fuel costs substantially, helping to support earnings.

Railroad Stocks Will Be Buy-Worthy … Eventually

An investor thinking about getting into railroad stocks now will have to be patient. It may be better for investors who have suffered the declines so far to wait as well.

In the meantime, automobiles and trucks have to be moved from factory to showrooms. Containers need to be offloaded from ships from Asia and moved inland. Grain must be transported from farms to terminals.

Most analysts see gains in 2016. That assumes the coal market turns around and the stock market stops panicking about China and the global economy.

Under those circumstances, all of the railroad stocks should benefit. UNP stock probably would be the biggest beneficiary — and is performing the best of the group in September with only a small loss.

Union Pacific is as close as there is to a national railroad and has major yards and facilities up and down the West Coast. It is a formidable player in intermodal freight from West to East — containers and trailers that get moved from ship to train to truck. Intermodal is 21% of revenue.

UNP competes with Burlington Northern in the West.

Norfolk Southern and CSX stock could be beneficiaries when the Panama Canal expansion project is completed, perhaps in spring 2016. That would allow container ships from Asia to bypass western ports and land cargoes at East Coast terminals.

One last point. The railroad stocks are trading at 10% or more below their 200-day moving averages. At some point, those prices will attract value investors and, probably, activist shareholders touting railroads as merger plays. Hedge fund manager Bill Ackman did just that with a 2012 coup at Canadian Pacific (CP) that brought in Hunter Harrison as CEO. Canadian Pacific held unsuccessful merger talks with CSX.

CP shares jumped 190% between Harrison’s arrival and a September 2014 peak. But they’re off 37% since.

As of this writing, Charley Blaine did not hold a position in any of the aforementioned securities.

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Article printed from InvestorPlace Media, https://investorplace.com/2015/09/railroad-stocks-cp-nsc-unp-csx-stock/.

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