Since calendar year 2000, which is a time period that includes our last two recessions, the major North American Railroad Companies have produced significantly above-average earnings growth. Moreover, the market has capitalized these exceptional operating results in almost lockstep fashion as price has followed the upward trend of earnings growth. Consequently, shareholders in railroads have enjoyed total returns significantly greater than the overall markets have been able to produce.
In addition to strong capital appreciation, each of these companies has increased their dividends to shareholders. However, due to the capital intensive nature of this industry, the four companies covered in this report have modestly spotty dividend growth records. With the exception of Canadian National (CNI), the other three companies either cut or did not increase their dividend coming out of the recession of 2001. Nevertheless, all four of these major railroads did average very strong dividend increases, with each of our four companies generating more than double the cumulative dividends of the average company as measured by the S&P 500.
As you review each of the earnings and price correlated F.A.S.T. Graphs™ on these four major railroad companies, note that over the same time period, the S&P 500 generated earnings growth of 5.8% per annum. Therefore, we find it interesting that even though these companies have generated earnings growth that is a minimum of two times with most of them more than three times greater than the S&P 500, they all can be purchased at PE ratios that are equal to or significantly below the index. Additionally, Canadian National pays a dividend that is equal to the S&P 500, while the other three offer higher yields.
The following table summarizes four major North American Railroads that appear to be attractively valued, and lists them in order of dividend yield highest to lowest. From left to right, the table shows the company's stock symbol and name. Next, two valuation metrics are listed side-by-side, the current PE ratio followed by the historical normal PE ratio for perspective. Then the five-year estimated earnings per share growth is shown next to each company's historical EPS growth providing a perspective of the past versus the future growth potential of each company. The final three columns show the current dividend yield, the company sector and its market cap.
A Closer Look at the Past and the Future Potential
Since a picture is worth 1,000 words, we'll take a closer look at the past performance and future potential of each of our five candidates through the lens of F.A.S.T. Graphs™.
Earnings Determine Market Price: The following earnings and price correlated historical graphs clearly illustrates the importance of earnings. The Earnings Growth Rate Line or True Worth™ Line (orange line with white triangles) is correlated with the historical stock price line. On graph after graph the lines will move in tandem. If the stock price strays away from the earnings line (over or under), inevitably it will come back to earnings. The historical normal PE ratio line (dark blue line with*) depicts a PE ratio that the market has historically applied.
The orange True Worth™ line and the blue normal PE ratio line provide perspectives on valuation. The orange line reflects the fair value of each company's earnings relative to its growth rate achievement, and the blue line reflects how the market has traditionally valued the company's stock relative to its fair value. The blue line represents a trimmed historical normal PE ratio (the highest and lowest PEs are trimmed). These lines should be viewed as barometers or aids for ascertaining sound buy, sell or hold decisions. Rather than seen as absolutes, they should be seen as guides to better thinking.
Norfolk Southern Corporation is one of the nation's premier transportation companies. Its Norfolk Southern Railway subsidiary operates approximately 20,000 route miles in 22 states and the District of Columbia, serves every major container port in the eastern United States, and provides efficient connections to other rail carriers. Norfolk Southern operates the most extensive intermodal network in the East and is a major transporter of coal and industrial products.
The consensus of 23 leading analysts reporting to Capital IQ forecast Norfolk Southern Corp's long-term earnings growth at 14.5%. Norfolk Southern Corp has medium long-term debt at 43% of capital. Norfolk Southern Corp is currently trading at a P/E of 11.9, which is below the value corridor (defined by the five orange lines) of a maximum P/E of 18. If the earnings materialize as forecast, Norfolk Southern Corp's True Worth™ valuation would be $167.84 at the end of 2017, which would be a 19.5% annual rate of return from the current price.
CSX Corporation, based in Jacksonville, Fla., is one of the nation's leading transportation companies, providing rail, intermodal and rail-to-truck transload services. The company's transportation network spans approximately 21,000 miles, with service to 23 eastern states and the District of Columbia. CSX's network connects more than 240 short line and regional railroads and more than 70 ocean, river and lake ports.
The consensus of 26 leading analysts reporting to Capital IQ forecast CSX Corp's long-term earnings growth at 14%. CSX Corp has medium long-term debt at 51% of capital. CSX Corp is currently trading at a P/E of 12.6, which is inside the value corridor (defined by the five orange lines) of a maximum P/E of 18. If the earnings materialize as forecast, CSX Corp's True Worth™ valuation would be $52.57 at the end of 2017, which would be a 18.3% annual rate of return from the current price.
It was 150 years ago that Abraham Lincoln signed the Pacific Railway Act of July 1, 1862, creating the original Union Pacific. One of America's iconic companies, today, Union Pacific Railroad is the principal operating company of Union Pacific Corporation , linking 23 states in the western two-thirds of the country by rail and providing freight solutions and logistics expertise to the global supply chain. From 2000 through 2011, Union Pacific spent more than $31 billion on its network and operations, making needed investments in America's infrastructure and enhancing its ability to provide safe, reliable, fuel-efficient and environmentally responsible freight transportation. Union Pacific's diversified business mix includes Agricultural Products, Automotive, Chemicals, Energy, Industrial Products and Intermodal. The railroad serves many of the fastest-growing U.S. population centers and emphasizes excellent customer service. Union Pacific operates competitive routes from all major West Coast and Gulf Coast ports to eastern gateways, connects with Canada's rail systems and is the only railroad serving all six major Mexico gateways.
The consensus of 25 leading analysts reporting to Capital IQ forecast Union Pacific Corp's long-term earnings growth at 15%. Union Pacific Corp has medium long-term debt at 32% of capital. Union Pacific Corp is currently trading at a P/E of 15.2, which is inside the value corridor (defined by the five orange lines) of a maximum P/E of 18. If the earnings materialize as forecast, Union Pacific Corp's True Worth™ valuation would be $242.67 at the end of 2017, which would be a 16.8% annual rate of return from the current price.
About Canadian National Railway Co : Directly from their website
CN - Canadian National Railway Company and its operating railway subsidiaries - spans Canada and mid-America, from the Atlantic and Pacific oceans to the Gulf of Mexico, serving the ports of Vancouver, Prince Rupert, B.C., Montreal, Halifax, New Orleans, and Mobile, Ala., and the key metropolitan areas of Toronto, Buffalo, Chicago, Detroit, Duluth, Minn./Superior, Wis., Green Bay, Wis., Minneapolis/St. Paul, Memphis, and Jackson, Miss., with connections to all points in North America.
The consensus of 20 leading analysts reporting to Zacks forecast Canadian National Railway Co's long-term earnings growth at 12.2%. Canadian National Railway Co has medium long-term debt at 38% of capital. Canadian National Railway Co is currently trading at a P/E of 14.4, which is inside the value corridor (defined by the five orange lines) of a maximum P/E of 18. If the earnings materialize as forecast, Canadian National Railway Co's True Worth™ valuation would be $160.40 at the end of 2017, which would be a 14.4% annual rate of return from the current price.
Summary and Conclusions
We believe that all four of these major North American railroads offer growth potential that is far greater than the average company. However, there are concerns regarding the effects that controversial new EPA standards could have on the domestic coal industry, which represents a major portion of each of these companies' business. However, we believe that most of these concerns are overblown and should prove more temporary than permanent. Therefore, most of the risk is already priced, in our opinion.
In conclusion, we believe that the North American Railroad industry represents a very attractive opportunity for the investors seeking above-average long-term capital appreciation, plus an opportunity for an above-average and growing long-term dividend income stream. Current valuations appear to compensate for any of the risks discussed in the paragraph above. However, we believe the prospective investor should carefully consider all these factors before committing to this apparently attractive long-term investment opportunity.
Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.