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With the Railroad Boom, You’d Expect Overpriced Stocks: Think Again

The wealth effect that comes with a stock market trading at new highs, a housing market finally heading north and an unemployment rate inching lower is loosening up wallets. Consumer spending is up 11% since last November and the Purchasing Managers Index considered a key barometer of manufacturing sentiment has risen nearly 9% during that stretch.

And when we’re buying (and building) more stuff it stands to reason that more stuff needs to be moved from point A to point B. And that’s already pushed major railroad stocks, such as CSX Corp. (CSX) and Norfolk Southern (NSC) well ahead of the market’s gain over the past few months, as seen in a stock chart.

^DJUSRR Chart

^DJUSRR data by YCharts

In addition to the tailwind of stronger economic activity, railroads are also benefitting from trucking’s headwind: Spot diesel prices have risen more than 150% since the end of the recession, pushing more logistics managers to choose tracks over trucks. According to the American Association of Railroads (AAR), one ton of freight can move 469 miles on a gallon of fuel.

The AAR reported that in February, intermodal rail traffic (shipping containers and truck trailers moved on rails) jumped 10.5% compared to a year earlier. That traffic is the highest since December 2010. Overall carload traffic was down 1.1%, but that was dragged down by weak demand for coal shipping. Excluding coal and grain, new carloads in February rose 4.5%. A nascent building recovery is the main engine of increase rail traffic: crushed stone and gravel shipments rose 17%, and lumber and wood products increase 10%.

One of the nation’s biggest rail operators, Burlington Northern Santa Fe (BNSF) a subsidiary of Berkshire Hathaway (BRK.B) reported a 4% volume increase in 2012; volume for consumer and industrial shipments rose 7%, while coal demand fell 4%. For the year BNSF revenue rose 7% and net earnings rose 13.5%.

Despite the recent run up in the price of publicly traded stocks, rail companies aren’t trading at off-putting valuations. You can use YChart Stock Screener to drill down into the rail sector (choose Sectors under “All Stocks”. Then choose Industrials, and then Railroads).

From there, you can start adding metrics. Plugging forward estimates (available to Platinum subscribers) shows that the three largest companies, Union Pacific (UNP), $65 billion market cap, CSX, $24.7 billion market cap, and Norfolk Southern, $23.6 billion market cap, trade near their historic norms, based on PE ratio.

UNP Forward PE Ratio Chart

UNP Forward PE Ratio data by YCharts

This week, the Wall Street Journal’s Betsy Morris, a one-time YCharts contributing editor, provided a smart and in-depth article on the advance of railroad companies in the U.S.

Amid the moderate growth that has defined the economy post-recession, all three have worked at cost efficiency. Each has managed to expand its operating margins over the past five years.

UNP Operating Margin TTM Chart

UNP Operating Margin TTM data by YCharts

Norfolk Southern’s bumpiness is in large part a function of its reliance on coal; which accounts for more than one-quarter of its volume. Utility demand for coal has dropped the past few years as natural gas prices plummeted. That said, over the past year the U.S. Wellhead price for natural gas has risen almost 50%. If the still-cheap price of natural gas continues to move higher, demand for coal could pick up as well.

For income investors, each of the big three U.S. rail companies pays a dividend. Norfolk Southern’s 2.6% current yield is the highest of the three. Over the past five years Norfolk Southern’s dividend payout has grown nearly 50%, yet the payout ratio is still under 40%. That gives management plenty of room to continue boosting the income payout, especially if rail volumes continue to grow along with the economy.

Carla Fried, a senior contributing editor at ycharts.com, has covered investing for more than 25 years. Her work appears in The New York Times, Bloomberg.com and Money Magazine. She can be reached at editor@ycharts.com.

Read more articles about: Company Analysis  

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