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Overview

Railroad companies have been relied upon to support growing trade and to move goods across large distances of land efficiently. Additionally, railroad companies enjoy significant barriers to entry given the difficulty, both financially and physically, of building up a new railroad network in North America. On December 15th of last year, I published an article titled, "2 Cheap Railroad Stocks To Buy For 2013" which outlined CSX (NYSE:CSX) and Norfolk Southern (NYSE:NSC) as investment ideas for 2013 given their relative cheapness, good dividend yields and strong competitive advantages. For 2014, in addition to CSX and Norfolk Southern, I believe that Union Pacific (NYSE:UNP) will also have a good year given profitability trends and valuation, especially relative to earnings growth. While declining volumes in coal shipments have hurt the railroads, an improving economic environment combined with the US shale boom has supported shipping volumes. On April 30th of this year, I published an article titled, "Railroad Stocks: Despite Recent Run-Up There Is Still Upside Potential" which illustrated the fact that while the earnings multiples in many of the railroad stocks had rallied they remained below historical norms. The current earnings multiples for Union Pacific, Norfolk Southern and CSX support the notion that there may still be further upside for the shares in these companies based upon historical ratios.

CSX Chart
(Click to enlarge)

CSX data by YCharts

CSX

CSX is a very strong market player, operating around 21,000 miles of track in the Eastern portion of the United States and Canada. In mid October, CSX reported modest earnings growth with strong margins. Consensus analyst estimates call for an 8% increase in EPS from this year to 2014. While the company has been hit by declining coal volumes, they do expect to still be able to report a rise in EPS for 2013 relative to 2012 EPS levels. The company is operating a sizable share buyback program while providing shareholders with a dividend yield of around 2.2% annually. Currently, CSX shares trade for around 14.7x TTM earnings, which is a discount to many peers in the sector. CSX is poised to benefit over the long term from sustained US economic and trade growth in addition to earnings momentum.

Norfolk Southern

While the company has been hit by declining coal volumes, Norfolk Southern was still able to grow Q3 railway volume by 4% thanks in part to the 14% growth in chemical volumes compared to Q3 2012. Operating largely in the Eastern region of the United States, Norfolk Southern operates a significant network of nearly 20,000 route miles. Norfolk Southern reported significant EPS growth of around 23% for Q3 compared to Q3 2012. The company has a share repurchase program and currently pays a dividend of around 2.4% to shareholders. Consensus analyst estimates call for the company to grow EPS by over 10% from this year to 2014. The company currently trades for around 15.4x TTM earnings, making it one of the cheaper players in the industry. Norfolk Southern is poised to benefit from an improving US economic climate producing greater rail volumes and subsequently greater profits for the company.

Union Pacific

Based in Omaha, NE, Union Pacific is the largest railroad company in the United States with a market cap of over $75 Billion. Union Pacific operates nearly 32,000 miles of route railroad track with nearly 46,000 employees. Back in October, Union Pacific reported a 13% gain in Q3 EPS when compared to Q3 2012. This was the company's best-ever quarter for a number of metrics including earnings. At the end of November, the company announced the authorization to purchase up to around 13% of the company's outstanding shares, through the end of 2017. The stock sports a dividend yield just below 2% and consensus analyst estimates call for EPS to rise by over 14% from this year to next. Union Pacific trades for around 17.9x TTM earnings. The company should continue to benefit from a growing US economy in addition to the continuation of the US shale boom which should continue to support rail volumes.

Conclusion

While railroad stocks have performed well this year, CSX, Norfolk Southern and Union Pacific are strongly positioned to perform well in 2014 given earnings trends and a potential expansion of earnings multiples.

Source: 3 Dividend-Paying Railroad Stocks For 2014