After the markets closed on September 19th, Norfolk Southern (NSC), a railroad operator based in Norfolk Virginia, issued lower Q3 guidance based upon declines in some markets and higher fuel surcharges. Coal and merchandise shipments are expected to decrease, although increases in intermodal shipments are expected to rise and at least partially offset those losses. In the wake of this negative guidance major railroad operators across the country saw significant drops in shares, ranging from 2-6%, during after hours trading.
Following the sharp drop in share prices associated with this negative guidance railroad operators may represent an excellent value play and a strong investment for the future for dividend growth investors.
NSC came out and issued reduced Q3 guidance, and the overall reduction in Q3 earnings is expected to be about $120M y/y. While $120 million over 1 quarter is not insignificant, based upon annual revenue from 2011 ($11.3 B) this represents a 1% drop in total revenue if this decrease were to continue over the course of an entire year. ($480 million/ $11.3 billion)
The share price for NSC dropped significantly following the news, falling 1.7% during trading September 19th, and nearly 6% during pre market trading. The share price was at $68.50 during pre-market trading. Based upon this new share price, and previous EPS estimates (which will likely be lowered with this guidance), shares trade with a P/E ratio under 12 and a dividend yield of just under 3.00%
With EPS expected to grow by 14% annually over the long term, and a 14% 5 year dividend growth rate, this significant price drop could offer an opportunity for DGI investors to get a high quality company at a significant discount.
In the wake of the negative guidance out of Norfolk Southern, other railroad operator stocks also suffered significant share price drops which could benefit investors over the short and long term.
CSX Corp (CSX)
CSX is the east coast's other large rail company. CSX shares sunk $1.00 (4.3%) in after hours trading. While CSX generates a large portion of revenue from the shipment of coal across the east coast the company also operates a large intermodal shipment operation that should recover some of that lost revenue.
Following the share price drop, shares of CSX can be purchased at a P/E ratio of 12.2. With long term EPS expected to grow by 13.4% and nearly a 30% operating margin the only concern is the balance sheet. The company generates enormous quantities of cash, and pays out 30% of earnings in the form of dividends yielding 2.6% with 5 year dividend growth of nearly 23%. If the company can pay down some of the debt on the balance sheet with the excess earnings shares of CSX may be able to soar.
Union Pacific (UNP)
Union Pacific provides rail transportation services primarily west of the Mississippi River. Union Pacific's rail network connects into Canada's as well as operates gateways into Mexico. The largest of the railroad operators, UNP has a market cap of $59.2 B with annual revenue in excess of $20B.
In the wake of the negative guidance issued by NSC, UNP shares have fallen 2.5% in after hours trading, and can now be snapped up for $121.90 per share. With this price, and $7.73 in EPS projected for 2012, UNP is trading with a P/E ratio of 15.8, a premium to other rails, but as the market leader. With a $2.40 annual dividend shares are yielding just under 2%. Looking forward UNP is expected to grow earnings 14% annually for the next 5 years. With the company's low payout ratio below 30%, rapid projected earnings growth, and 5 year dividend growth rate near 28% UNP could be an investment for the future.
While the downside guidance issued by NSC will likely dampen share prices of railroad operators in the near term, long term growth opportunities for rail operators appear significant and substantial. With significant barriers to entry, these companies operate with little fear of newly introduced competition, and can pass along a portion of increases in fuel prices to customers. As energy prices continue to rise the benefits of rail to ground transportation are increased and it becomes efficient and cost effective to send shipments via rail than by traditional trucking.
It seems that in the near term shipments may continue to decline and depress earnings, but as the economy stabilizes, and again begins to grow, these rail operators will stand poised for explosive growth.
On the heels of this negative guidance and associated share price drops I would encourage dividend growth investors to evaluate rail operators to determine whether adding them to their portfolio may be a good long term decision.