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Oil Creates Opportunity in Railroad Stocks

After low oil prices drove down railroad stocks, investors are looking to pick up bargains

As most sectors in the market steam ahead in advance of the New Year, the obvious exception has been oil and energy stocks. Major oil stocks as well as smaller players have all been slammed by falling oil prices.

Railroad track points 630
Source: iStockphoto

But there’s at least one sector that oddly enough may benefit from oil’s lower price, at least for investors looking to buy. It’s a sector that the market may have mispriced: the railroad stocks.

Railroad Stock Prices Fall

After railroad stocks had made an impressive run this year, with gains on average of more than 33%, the railroad stocks screeched to a halt. When OPEC reiterated in late November it would not be cutting back oil production, railroad stocks nearly fell off the tracks.

Norfolk Southern Corp. (NSC) stock dropped from  $117 a share on Nov. 26 to $106 on Dec 1, a decline of more than 9%. NSC stock continued to fall until it hit $101 on Dec 12. It’s now trading at about $110.

CSX Corporation (CSX) fell, too, as did other big name rail stocks. Union Pacific Corporation (UNP), Canadian Pacific Railway Limited (USA) (CP), Canadian National Railway (USA) (CNI), and Kansas City Southern (KSU), all joined the temporary free fall.

Why the free fall? Crude oil, of course.

The Market’s Logic on Crude

The market’s perception of the railroad stocks was fairly obvious and straightforward. It could be summed up like this: “as crude goes, so go the railroad stocks.”

So with crude oil prices already down at that time by nearly 30% from its $100 level, OPEC’s decision was seen as certain to drive prices down further, which would make the railroad stocks suffer. After all, railroads hauled crude oil, especially from the boom areas for fracking, like the Bakken.

The railroad stocks would surely be hurt the same as they were supposed to feel pain from a sagging coal industry. So the stocks sold off.

Railroad Stocks and Oil

A Trefis article published on examined some of the data behind the assumption that falling oil prices would hurt railroad stocks. The numbers from UNP stock show a different picture.

Roughly 1.5% of total shipping volume in the first nine months of this year was from crude oil. The estimate for revenue on this volume was just over 2% of UNP stock’s total revenue.

The article concluded that railroads would be able to weather falling crude prices just fine and that the drop in their stock prices was unjustified.

We would go further and say that since the market has misunderstood the relationship between falling crude oil prices and the railroad stocks, the market’s faulty perception and action has created a buying opportunity in railroad stocks.

The Health of Railroad Stocks

RR stock 1 year chart
Click to Enlarge
A main factor in the buying opportunity for the railroad stocks is their healthy fundamentals. Earnings for the railroad stocks have been strong. Although coal hauling volume has fallen off for some of the railroad stocks, they’ve still produced impressive financial results.

UNP stock in October posted terrific third quarter earnings. Union Pacific earned $1.53 per share compared to $1.24 in the same quarter a year ago. Revenue rose 11% year-over-year as shipping volumes increased by 7%.

NSC stock also had a good quarter, though analysts didn’t think so. The company reported earnings per share of $1.79 compared to $1.53 in the same quarter last year, with revenue of $3.02 billion, a 7% increase. Analyst estimates called for more, but these are still outstanding numbers.

CSX stock joined the group with solid third-quarter earnings as well. It reported 51 cents earnings per share, up from 45 cents a year ago, on $3.2 billion in revenue, an 8% increase from last year’s third quarter. Its guidance included a prediction of double-digit profit growth in 2015.

Bargains Still

In addition to UNP stock, NSC stock and CSX stock, investors might want to look at CP stock, CNI stock and KSU stock. But the bargain prices may not last long if investors eventually reject the idea that low oil prices will hurt the railroad stocks.

Already the railroad stocks’ prices have started to rise again, as the market heads toward the end of the year. But NSC stock still traded at nearly 10% off from its 52-week highs, so prudent long-term buyers take note.

With the combination of solid fundamentals and growth, along with the market’s wrong idea about oil’s relationship to railroad stocks, there are still some good buys available.

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

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