Many investors have bemoaned the volatility and poor secular trends of coal, going so far as to argue that it will leave railroads in dire straits. Yes, a large part of rail business comes from the coal industry, but diversification meaningfully reduces risk. In addition, railroads still remain by far the cheapest way to ship goods and that is not going to change any time soon. I thus encourage investors to open a large stake across the industry.
If you take a logarithmic regression of Union Pacific's (UNP) EPS over the past 7 years, 2016 EPS comes out to around $9.46. At a multiple of 15x, the future value of the railroad is $141.90. This, however, actually understates the potential of the world's largest railroad. Analysts expects 2013 EPS to be around $9.30 and grow 15% annually in the near-term, so 2016 EPS should be closer to $14.13. Discounting backwards by 10% at a 15x multiple would place the intrinsic value at $131.60.
Investors should note that over the last 5 years, Union Pacific has generated 16.2% annual EPS growth. It is reasonable to expect lower growth as company's mature, so the 15% expectation is reasonable. Analysts currently rate the stock a "buy" with a $128.68 price target according to data from FINVIZ.com.
If you take a logarithmic regression of CSX's (CSX) EPS over the past 7 years, 2016 EPS comes out to around $2.24. Analysts expect the company to generate 2013 EPS of $2.06 and grow 9.6% annually thereafter into the near-term. That means 2016 EPS of around $2.71. Taking the average between my estimate and the Street's, 2016 EPS may fall near $2.38. At a multiple of 15x, CSX's future stock value is $35.70. Discounting backwards by 10% yields a price target roughly in-line with the current market valuation.
The company is nevertheless a safe investment. Performance was strong in the first quarter of 2012 with management beating expectations by 13.2%. Moreover, the company trades at just a respective 13x and 11x past and forward earnings, which is well below the S&P 500's 15.4x multiple. Analysts, accordingly, rate the stock a "buy" according to data from FINVIZ.com.
Norfolk Southern (NSC) is a less popular investment than Union Pacific and CSX, as indicated by trading volumes, but it nevertheless is an attractive one in terms of both safety and value. Over the last 5 months, the company has beaten expectations by an average of 5.8%. The PEG ratio, moreover, is below 1 at 0.9, which indicates that future growth has yet to be fully factored into the stock price.
Norfolk Southern trades cheaply at a respective 12.7x and 11.2x past and forward earnings. Over the past 5 years, annual EPS growth was 8.8%. Analysts are expecting 14.1% over the next 5. That means 2016 EPS will be around $9.77. At a 15x multiple, the company would be worth approximately double its current valuation. Discounting backwards by 10% yields a price target of $91, which provides nearly a 25% margin of safety. On top of a 2.6% dividend yield, I solidly recommend Norfolk Southern to your rail portfolio.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: We seek IR business from all of the firms in our coverage, but research covered in this note is independent and for prospective clients. The distributor of this research report, Gould Partners, manages Takeover Analyst and is not a licensed investment adviser or broker dealer. Investors are cautioned to perform their own due diligence.