CSX Corp. Preferred In The Transportation Sector

| About: CSX Corporation (CSX)
This article is now exclusive for PRO subscribers.

The Street is currently bullish on transportation, rating deliver service firm United Parcel Services (NYSE:UPS), railroad CSX Corp. (NYSE:CSX), and Southwest Airlines (NYSE:LUV) a "buy" or better. CSX is most preferred with a near "strong buy" rating - a sentiment that I share upon reviewing the fundamentals. Southwest - in more ways than one - faces the most headwinds with uncertainty over integration, labor, and margins.

From a multiples perspective, UPS and CSX are both trading under their 5-year average PE multiples. UPS trades at a respective 18.1x and 14.1x past and forward earnings while CSX trades at a respective 13.3x and 10.2x past and forward earnings. UPS offers the highest dividend yield at 2.7% with the lowest beta at 20% less volatility than the broader market.

At the fourth quarter earnings call, CSX's CEO, Michael Ward, noted strong progress:

"Last evening, we were pleased to report record earnings per share for the fourth quarter and full year 2011. Fourth quarter EPS was up 13% to a new fourth quarter record of $0.43 per share. These results were driven by top line growth, reflecting strong core pricing and fuel recovery, as well as an excellent service product. Service measures are now at high levels, thanks to the outstanding execution of our operating team and the resource investments we made in the second half of the year. We expect service levels to remain high going forward".

The firm delivered results that were roughly in-line with expectations. Export coal contracts are proving stable as ROE is set to take off. Over the next few years, ROE is trending towards 25.4%, a 420 basis improvement.

Consensus estimates for CSX's EPS forecast that it will grow by 13.2% to $1.89 in 2012 and then by 14.3% and 14.8% in the following two years. Assuming a multiple of 15.5x and a conservative 2013 EPS of $2.14, the rough intrinsic value of the stock is $33.17, implying 49.8% upside.

UPS will similarly benefit from pro-growth free trade legislation. With only about a tenth of the market in Europe, the firm has plenty of room for expansion. Its $200M European air hub project will increase capacity by 70% and allow for greater efficiency through increases to scale. With that said, recent appreciation has factored in much of these catalysts and substantially closed the value gap.

Consensus estimates for UPS' EPS forecast that it will grow by 14.7% to $4.85 in 2012 and then by 13% and 16.4% in the following two years. Modeling a CAGR of 14.7% for EPS over the next three years and then discounting backwards by a WACC of 9% yields a fair value figure of $80.73, implying just 4.5% upside.

Moving onto Southwest, we find an airline company that has been one of the few in its industry to not declare bankruptcy. Not coincidentally, Southwest has an investment grade rating. With that said, integrative AirTran is likely to prove difficult in terms of managing labor issues and wage negotiations.

Consensus estimates for Southwest's EPS forecast that it will grow by 90.7% to $0.82 in 2012 and then by 31.7% and 9.3% in the following two years. Assuming a multiple of 12.6x and a conservative 2013 EPS of $1.05, the rough intrinsic value of the stock is $12.60, implying 30.7% upside.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.