Full steam ahead for rail stocks

The Fed's projection for stronger GDP growth in years to come should spell upside for rails.

By InvestorPlace Jun 20, 2013 10:57AM

iplogoRailroad Crossing with Train (© Edmond Van Hoorick/Photodisc/Getty Images)By Alyssa Oursler

Domestic railroad stocks have been chugging along so far in 2013, outpacing the broader market's gains.

Since Jan. 1, Norfolk Southern (NSC) and Union Pacific (UNP) have each gained 25%, CSX Corp.'s (CSX) boomed 26%, while Canadian Pacific Railway (CP) is the 'laggard' with a 23% run in the books.

Plus, CP was faring better before news broke that activist investor Bill Ackman is trimming his stake in the railroad. So, should investors fear the sector's run-up and follow Ackman out the door?

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Hardly. Instead, economic data just released by the Federal Open Market Committee confirm that more upside is likely around the bend. As you're probably aware, railroads are just one breed of cyclical stocks -- stocks that generally flourish as the economy recovers, but also follow it south.

Just take a look at the two charts below showing CSX Corp. and Norfolk Southern's stock performance vs. U.S. GDP growth over the past five years. The correlation is unmistakable.

railroad stocks 6.13 ytd
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It's almost no wonder, then, that an upward near-term GDP revision back in January was followed by an eye-popping first quarter. A quick sample:

  • CSX Corp. posted record first-quarter operating income, operating ratio, earnings and earnings per share in April, while also raising its dividend and announcing a new share buyback program.
  • Canadian Pacific also posted its best first quarter ever, including a whopping 52% growth in earnings on a 9% improvement in revenue. As a result, CP expects a 40% overall increase in earnings for 2013.
  • Union Pacific was able to improve on and revenue for the same time period, despite weaker shipments of coal and ag products.

Of course, nothing lasts forever. Since then, a downward near-term revision came in March, and yet another one came yesterday. Now, full-year GDP growth is slated for 2.3% to 2.6% -- lower than a previous range that went up to 2.8%, and a substantial drop from even earlier expectations around 3% for the year.

But look at this chart showing GDP forecasts through 2015 ... and keep in mind the correlation with rail stocks' performance from the charts above.


Looking further down the road -- as you should as an investor -- GDP growth is slated to keep moving upward over the next year or two. As a result, cyclical railroads stocks should follow.

Heck, the Fed actually raised its predictions for 2014 too, with the new range calling for growth between 3% to 3.5%. That, along with the 2.9% to 3.6% range for the year after, makes for a pretty substantial improvement from the 2.4% last recorded on the GDP line plotted against NSC and CSX.

The bottom line: As many have mentioned amid chatter about interest rates and stimulus, we are still far from a full recovery (InvestorPlace). That means the economy should keep on getting better, and that's what the Fed's policymakers are projecting. The best days aren't in the books yet ... so railroads still have room to run as the economy gains steam.

Any weakness in the second half of the year should be seen as a buying opportunity.

As of this writing, Alyssa Oursler did not own a position in any of the aforementioned securities.

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