By Richard Lloyd Evans
US freight railroads had a stellar 2011, and looking out into 2012, there are nothing but roses scattered along the rails of the country. Despite the run-up in railroad stock, there are still some great buys on the rails. In the following article, I will first provide a quick analysis of the railroad industry. Then, I will look at five railroad stocks which prove there is still an opportunity to get in and capitalize on this market.
The key to recent railroad stocks' success was the massive impact of the Great Recession in 2007-2008. Up to that point most railroads were dinosaurs, bloated by inefficient cost structures and hobbled by union contracts which were horribly cost prohibitive and anti-productive. They came with massive debt in the guise of underfunded retirement and medical plan liabilities. The financial meltdown caused everyone to make tough choices. Railroad union commitments were reworked, cost structures were slashed, and the railroads who came through the fire were much leaner, nimble and more efficient.
With 2011 in the books commodity exports have been strong, with construction components, lumber and motor vehicle volumes for rail shipment increasing over 30% year over year, while petroleum products shipped rose 29% year over year. There have also been significant upticks in transportation volumes of other basic materials, especially coal. The first two weeks of January 2012 continued the trend, with total rail carloads increasing by 5.5% over the same period in 2011.
While shipping levels of basic materials are up, high energy prices have given the rails big inroads over other transportation options like trucking companies since fuels costs have a smaller impact on rail. On average, railroads are 300% more fuel efficient than trucks. Railroads are increasing market share in transportation and are turning into earnings machines in the current environment. So long as fuel costs remain elevated and commodities continue strong railroad companies are practically printing money. These five companies each look like strong buys:
CSX Corporation (CSX) has been trading around $23, with a market capitalization approaching $24 billion. The stock valuation has worked within a 52-week trading range of $17.69-$27.06. Its earnings per share has been $1.67 for the trailing twelve months for a price to earnings ratio of 13.85 and price to earnings growth at 0.301. CSX benefits greatly from the export of basic commodities such as coal and revenues, which are expected to continue to grow strongly in 2012. Shares could very well see a price above $40 by the time the company announces third quarter 2012 results.
Perhaps an even stronger buying opportunity is in Kansas City Southern (KSU), which has seen a small correction in its share price. With a market capitalization of $7 billion, a recent share price of $70 is just below the top of its 52 week range of $45.63-$74.73. Earnings per share is $3, with a price to earnings ratio of 23.50 and a price to earnings growth of 1.285.
The company announced its 4th quarter 2011 results with a thumping 85% rise in profits. The trouble, however, is that analysts had forecast an even higher profit number and revenues were "merely" $530 million instead of $550 million, so the stock took a hit. Kansas City Southern has assets throughout the southern Midwest and even into Mexico, and would make an important connector for some of the larger railroads. It could very well become a takeover target in the near future by some of the big boys.
One of those big boys is Union Pacific Corporation (UNP), which saw a recent price near $116, at the top of its 52-week trading range of $77.73-$117.40. It has trailing twelve months earnings per share of $6.72, a price earnings ratio of 17.28, and a price to earnings growth ratio of 0.999. Union Pacific has erupting earnings and the financial position to be a player, as some of the smaller railroads could tie in well with its own network of railroads that cover large stretches of the West.
Eastern US railroad Norfolk Southern Corporation (NSC) sports a recent price near $73 and a market capitalization of $24 billion. It trades within a 52-week range of $57.70-$78.50 with earnings per share of $5.47, which calculates to a price to earnings ratio of 13.46 and a price to earnings growth of 1.007. Norfolk is another smaller railroad which looks to be well positioned to service the growing trend of sending Appalachian coal to overseas markets. With its small size and important rail network connections, the company could be a prime takeover candidate in the coming year.
Up north, Canadian Pacific Railway Limited (CP) boasts a $12 billion market cap with a recent price of $74, a 52-week trading range of $44.74-$73.06, and earnings per share at $3.28 for a price earnings ratio of 22.55. The stock has no meaningful price to earnings growth ratio. Canada Pacific is interesting for two reasons: It was slower than its American peers in cutting costs, and it was also slower in moving into a more efficient model. However, the company has strong connections in servicing the vast Canadian oil sands projects in the interior.
All five railroads are riding strong results and look to continue their success in 2012. Paired with the possibility of consolidation in the rail industry, there are a number of buys in the railroad sector, including each of these five stocks.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.