UBS Prefers Railroad Stocks CN Rail and Norfolk For Now, Union Pacific Long Term

Includes: CNI, NSC, UNP
by: FP Trading Desk

While it might scare some investors to hear that year-to-date rail freight volumes have fallen more than twice as much as they did during the worst year of the last recession, prices are mitigating the negative impact on revenues, according to UBS Securities.

Volumes are down 2.7% so far in 2007, whereas they fell 1.3% in 2001. Meanwhile, revenue growth for the Big 6 rails in the first quarter of 2007 came in at 2.5%, roughly three time stronger than 2001, demonstrating that the current “freight recession” isn’t as bad as it sounds.

Railroad companies’ ability to extract price should overcome volume weakness and continue to yield healthy earnings and free cash flow growth, UBS said in a research report, adding that these companies should further benefit when old ‘legacy’ contracts are repriced.

The firm expects Norfolk Southern Corp. (NYSE:NSC) and Canadian National Railway Co. (NYSE:CNI) to benefit most from this secular pricing trend and are its top picks in the sector.

These names are not only cited for having low risk due to quality operations and management, but UBS also points out that they are “the two cheapest stocks in the sector with the highest free cash flow yields.”

Over the long term, UBS prefers Union Pacific Corp. (NYSE:UNP) given its high proportion of ‘legacy’ contracts.