3 railroad stocks that keep rolling

These lines are cashing in on booming intermodal shipments.

By InvestorPlace Jun 15, 2012 10:10AM

By Susan Aluise

 

Freight railroads are at a crossing. While the volume of freight rail's core staples like coking coal, grain and scrap metal is down significantly compared to last year, volume of "intermodal" freight -- shipments that travel in containers or trailers and can be handled by rail, ship or truck -- is rising.

 

And that growth is likely to help some publicly traded freight rail companies deliver healthy returns to shareholders.

 

Railroads have had to contend with adversity so far this year: Total carload volume is down more than 3% compared to the same period last year. Cheap natural gas, regulatory pressure and a warmer-than-usual winter drove down coal volume, which accounts for more than 35% of all rail shipments. Grain exports are sluggish because of the mild drought in the nation's heartland and rising international production.

 

But intermodal volume is 4% higher today than it was a year ago. And if you remove coal and grain from the equation, freight rail volume rose by nearly 8% in the first quarter of this year, according to the Association of American Railroads.

 

Intermodal is becoming an increasingly attractive option for shippers because of tight trucking capacity. Railroads can transport a ton of freight more than 480 miles on a single gallon of diesel, making them more efficient than other transport modes. As a result, overall freight rail revenue rose by more than 15% in 2011, and rails also gained market share from truckers -- especially in intermodal, according to a Council of Supply Chain Management Professionals report released this week.

 

For investors, the best railroad stocks are those that are well prepared to take advantage of growing intermodal traffic. Here are three freight railroads that are poised to keep on rolling:

 

CSX (CSX) would have taken a huge hit on its first-quarter earnings released in April because coal volume dropped 14%. Instead, intermodal shipments soared, accounting for 37% of total volume in the first quarter. That made all the difference: CSX earnings beat analysts' estimates as first-quarter profits rose 14%, to 43 cents a share, on revenue of nearly $3 billion, versus expectations of 35 cents a share.

 

CSX shares have wiggled a lot in 2012 but currently are trading around $22 -- up about 4%, which is slightly worse than the broader markets. CSX looks slightly undervalued, with a price-to-earnings-growth ratio of 0.8 and a fairly low forward price-to-earnings ratio of around 11. The company also offers a decent 2.6% dividend yield.

 

CSX has a lot going for it in intermodal. It has been cashing in on increased conversion of highway intermodal shipments to rail. Growth in its UMAX interline container program and new international volume bode well. CSX could find its way up to about $27.

 

Norfolk Southern's (NSC) domestic intermodal operations helped offset weakness in coal shipments. First-quarter intermodal revenue rose 9%, reflecting a volume increase of 5%. NSC beat the Street on both the top and bottom lines: Earnings rose 26% in the first quarter to $1.23 a share; revenue grew 6% to $2.8 billion.

 

After sliding for the first part of the year, NSC gained some momentum near late April, only to watch shares fall again in May. NSC shares now are down more than 5% this year. Like CSX, it's attractively valued with a forward price-to-earnings of around 10 and a price-to-earnings-to-growth ratio of 0.8, and also like CSX, it sports a nice dividend of about 2.8%.

 

The company's intermodal terminal in Franklin County, Pa., is scheduled to open later this year, and the intermodal facility in Birmingham, Ala., that began construction last year are big bets on that business. I like NSC at a price target of $85.

 

Union Pacific (UNP) expanded its intermodal revenue by 15% in the first quarter, reflecting a small increase in volume and higher revenue per container. It's also using innovations in technology such as smartphone apps to make gate reservations at intermodal facilities. In April, Union Pacific reported a 35% increase in first-quarter earnings to $1.79 a share, on revenue that rose 14% to $5.1 billion, beating analysts' estimates on the top and bottom lines.

 

Union Pacific stock has made enormous progress since bottoming out in early October 2011. It has gained 40% since then, including a nice 8% run year-to-date. At nearly $54 billion, UNP is the largest freight railroad in the U.S. by market cap. It is fairly valued at a price-to-earnings-to-growth ratio of 1 and a forward price-to-earnings of a little more than 12, and has a price-to-earnings-to-growth ratio of 1; its dividend also is a bit more modest than CSX and NSC, at 2.1%.

 

Union Pacific has size and intermodal growth, plus rising volume of oil and petroleum product transport. Buy UNP, with expectations that it could reach $125.

 

As of this writing, Susan J. Aluise did not hold a position in any of the aforementioned securities.

 

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