Freight railroads are at a crossing. While the volume of freight rail’s core staples — coking coal, grain and scrap metal — is down significantly compared to last year, volume of “intermodal” freight — shipments that travel in containers or trailers and can be handled by rail, ship or truck — is on the rise.
And that growth is likely to help some publicly traded freight rail companies deliver healthy returns to shareholders.
It’s no secret that railroads have had to contend with some adversity so far this year: Total carload volume is down more than 3% compared to the same period last year. Cheap natural gas, regulatory pressure and a warmer-than-usual winter drove down coal volume, which accounts for more than 35% of all rail shipments. Grain exports are sluggish due to the mild drought in the nation’s heartland and rising international production.
But intermodal volume is 4% higher today than it was a year ago. And if you remove coal and grain from the equation, freight rail volume rose by nearly 8% in the first quarter of this year, according to the Association of American Railroads (AAR).
Intermodal is becoming an increasingly attractive option for shippers because of tight trucking capacity. Railroads can transport a ton of freight more than 480 miles on a single gallon of diesel, making them more efficient than other transport modes.
As a result, overall freight rail revenue rose by more than 15% in 2011, and rails also gained market share from truckers — especially in intermodal, according to a Council of Supply Chain Management Professionals report released this week.
For investors, the best railroad stocks are those that are well prepared to take advantage of growing intermodal traffic. Here are three freight railroads that are poised to keep on rolling:
CSX
CSX (NYSE:CSX) would have taken a huge hit on its first-quarter earnings released in April because coal volume dropped 14%. Instead, intermodal shipments soared, accounting for 37% of total volume in the first quarter. That made all the difference: CSX earnings beat analysts’ estimates as first-quarter profits rose 14%, to 43 cents a share, on revenue of nearly $3 billion versus expectations of 35 cents a share.
CSX is trading near $22, around 25% above its 52-week low last October. With a market cap of nearly $23 billion, CSX has a price-to-earnings growth (PEG) ratio of 0.8, indicating the stock may be undervalued, and a fairly low forward P/E of around 11. It also has a current dividend yield of 2.6%.
Bottom Line: CSX has a lot going for it in intermodal. It has been cashing in on increased conversion of highway intermodal shipments to rail. Growth in its UMAX interline container program and new international volume bode well.
Buy CSX with a price target of $27.
Norfolk Southern
Norfolk Southern’s (NYSE:NSC) domestic intermodal operations helped offset weakness in coal shipments. First-quarter intermodal revenue rose 9%, reflecting a volume increase of 5%. NSC beat the Street on both the top and bottom lines: Earnings rose 26% in the first quarter to $1.23 a share; revenue grew 6% to $2.8 billion.
NSC is trading around $68, about 18% above its 52-week low last October. With a market cap of about $22 billion, NSC has a PEG ratio of 0.8, indicating the stock could be undervalued, and a forward P/E a little over 10, which is at the low end of the freight rail sector. It also has a current dividend yield of nearly 2.8%.
Bottom Line: The company’s intermodal terminal in Franklin County, Pa., is scheduled to open later this year, and the intermodal facility in Birmingham, Ala., that began construction last year are big bets on that business.
I like NSC at a price target of $85.
Union Pacific
Union Pacific (NYSE:UNP) expanded its intermodal revenue by 15% in the first quarter, reflecting a small increase in volume and higher revenue per container. It’s also using innovations in technology such as smartphone apps to make gate reservations at intermodal facilities. In April, Union Pacific reported a 35% increase in first-quarter earnings to $1.79 a share, on revenue that rose 14% to $5.1 billion, beating analysts’ estimates on the top and bottom lines.
UNP is trading around $113, nearly 46% above its 52-week low last October. With a market cap of nearly $54 billion, UNP is the largest freight railroad in the U.S. by that measure. It has a PEG ratio of 1, indicating the stock is fairly valued, and a forward P/E a little over 12, which is the midrange for the freight rail sector. It also has a current dividend yield of 2.1%.
Bottom Line: Union Pacific has size and intermodal growth, plus rising volume of oil and petroleum product transport.
I rank UNP a buy with a price target of $125.
As of this writing, Susan J. Aluise did not hold a position in any of the stocks named here.
