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3 Railroad Stocks to Ride Now

Intermodal growth, petroleum products offset declining coal volumes

By Susan J. Aluise, Aviation, Auto & Transportation Writer

It’s no secret that Warren Buffett loves railroads — five years ago, his Berkshire Hathaway (BRK.B) ponied up $34 billion to acquire Burlington Northern Santa Fe.

railroad stocks

Some observers thought the “Oracle of Omaha” was off his game, making such a huge investment in a 150-year-old industry in the depths of the Great Recession. But the last laugh was Buffett’s as railroads’ fortunes have soared on shale oil transport and growth in intermodal containerized freight.

Since Buffett added BNSF to BRK’s portfolio in 2009, railroads have experienced a paradigm shift in their business models.  Railroad stocks took their lumps during the recession as weaker merchandise shipments could not compensate for power companies’ reduced demand for coal. But as the economy recovered, shippers embraced rail’s economic value proposition — since railroads can move a ton of cargo 425 miles on a single gallon of fuel.

So what does all this mean for investors? Buffett’s ongoing love of the prospects of railroad stocks signals an opportunity for individual investors, too. Here are three railroad stocks to ride now:


railroad stocks, csxOn Tuesday, CSX (CSX) posted strong second-quarter earnings of 53 cents a share on a top line of about $3.2 billion. Revenue grew 6.5% in the quarter, in large part because of strong performance in transport of petroleum products, grain, construction products and intermodal. Although the railroad’s declining coal volumes continued to drag shipping volumes, net profits still increased overall by 2%. The results beat analysts’ profit expectations and narrowly missed revenue targets.

CSX is investing strategically in its business, setting aside an additional $100 million for capital investment this year — bringing the total capital investment to $2.4 billion. The capital investment is being used to purchase new, more rugged tank cars to haul petroleum products and to develop intermodal infrastructure.

The biggest boon for railroad stocks in general — and CSX in particular — has been growth in transporting shale oil and other petrochemical products from fracking operations in North Dakota’s Bakken shale formation and elsewhere. Consider that major railroads delivered 434,042 carloads of crude oil in 2013 — 83% higher than the prior year, according to the Association of American Railroads.

CSX stock has gained more than 8% year-to-date, and the fundamentals look solid. Although CSX’s price-to-earnings-growth (PEG) ratio is 1.6, suggesting the stock may be overvalued, it has a forward P/E of 14.5 — about average for the sector. CSX stock has a current dividend yield of 2.1%.

Union Pacific (UNP)

Unionrailroad stocks, union pacific Pacific (UNP) is the grand-daddy of freight railroads in the U.S., boasting diversified freight contracts that include intermodal, chemicals, coal, agricultural, and automotive business. When UNP reports earnings on July 24, Wall Street is looking for earnings of $1.46 per share and revenue of a little less than $6 billion for UNP’s fiscal second quarter.

The railroad’s growth in the all-important intermodal freight sector will be an important locomotive for UNP stock. Intermodal freight, which is packed in containers and can be moved by truck, rail or ship, is a winning play for railroads. Last month, Intermodal volume grew by a whopping 6.7% in June to more than 269,000 container units — the highest volume in history, according to the Association of American Railroads.

Against the backdrop of tighter trucking capacity, railroad stocks are poised to build on recent gains. Like rival BNSF, UNP’s strong position in the key West Coast ports of Oakland, Calif. and Portland, Ore. gives the railroad an edge. Last month, UNP increased its premium intermodal services from the West Coast to Chicago and it is moving forward with commitments to invest $4.1 billion to improve infrastructure in 2014.

UNP stock has gained more than 20% year-to-date and still has room to run. Although UNP’s PEG ratio of 1.2 and its forward P/E of 16 suggest the stock could be overvalued, earnings growth and a current dividend yield of 1.8% further sweeten UNP’s value proposition.

Canadian Pacific Railway (CP)

railroad stocks, canadian pacific railwayCanadian Pacific Railway (CP) is one of the two major Class I railroads in Canada, with 14,700 miles of track and infrastructure stretching from Vancouver to Montreal and into the Midwest and Northeast U.S.

CP reported a quarterly EPS of $1.96 on Thursday, a whopping 48% above the same quarter last year. CP’s revenue hit $1.56 billion — a 12% rise compared to the same quarter a year ago. Not surprisingly, CP benefited substantially from the fracking boom as crude oil shipments climbed 18%.

The growth in movement of crude oil and petrochemical products by rail has prompted a thorough review of safety measures — particularly after several high-profile derailments, but railroads, oil companies and federal transportation officials are developing stricter procedures and stronger tank cars to minimize the impact of freight rail accidents.

CP earnings were also boosted by a bumper crop of North American wheat. In the aftermath of a tough winter, CP has struggled to move a bumper crop of wheat from western Canada. More recently, though, the backloads have narrowed and the shipments are getting back on track.

CP has a PEG ratio of 1.03, indicating that the stock is valued about right — but its forward P/E of nearly 18 is a bit higher than that of its peers. The nominal current dividend yield of 0.7% is nothing to write home about, but the stock has gained almost 30%  so far this year. CP’s margins have been improving as the railroad implements a more focused cost-cutting strategy. Further investments in infrastructure — and more rugged tank cars for oil and flammable liquids transport — will pay off in the future.

As of this writing, Susan J. Aluise did not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media,

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