3 Stocks To Catch The Hidden Rail Boom Before It's Too Late


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A confluence of factors -- including the heavy hand of regulators in Washington, D.C. -- is creating an unprecedented profit opportunity for a select few companies in the rail industry.

The federal obstacles for railroads certainly appear daunting.

For starters, new EPA regulations set to take effect in January are placing a cloud over the U.S. operation of locomotives -- the big engines that make the entire industry go.

On top of that, the Department of Transportation proposed new safety rules last month that could force U.S. railroads to upgrade portions of their rolling stock within two years, especially tanker cars, at huge costs. The proposals include more complex railcar standards, new mandates on braking controls, and speed restrictions.

At the same time, ongoing efforts by the White House to discourage coal production - a major source of freight revenue - appear to be making inroads, with coal companies shutting mines and lowering output. (My colleague Joseph Hogue recently detailed his favorite income trade in the sector despite those headwinds.)

There is a silver lining, however, to all the government involvement in railroads for at least three U.S. companies. In fact, the more federal red tape comes down the pike, the sweeter it is for these three.

They are all three manufacturers of rail equipment and vehicles, and all are running at or near full capacity to cope with a rush of orders ahead of federal deadlines. Even sweeter, at the same time they are serving as a proxy for a resurgent U.S. economy, and they are shipping huge amounts of shale oil and gas from the new American energy boom.

The stocks of all three are up sharply, but there is still time to get in before their valuations catch up with their growth prospects.

The companies are railcar makers Greenbrier (NYSE: GBX ) and Trinity Industries (NYSE: TRN ) , and locomotive manufacturer Wabtec (NYSE: WAB ) .

Railroads have always been good indicators of the health of an economy -- the more the economy grows, the more products are shipped by rail to meet increased demand. Greenbrier, Trinity and Wabtec are perfectly positioned to benefit from the macro growth trend because the more the economy grows, the more demand there is for their equipment.

These companies are also benefiting from ongoing growth in intermodal traffic, the traffic that occurs when truck trailers full of cargo are loaded onto trains for at least part of their routes instead of going exclusively by highway. Intermodal shipping by rail is setting records for volume and was up about 7% year-over-year in July.

Lastly, Greenbrier, Trinity and Wabtec are also beneficiaries of one of the biggest business stories in America -- namely the drive toward energy self-sufficiency propelled by the fracking boom. The Wall Street Journal reported last month that oil shipments by rail are growing exponentially.

Like many heavy cyclical stocks, these three tend to trade at respectable multiples. Greenbrier, for instance, has a forward price-to-earnings (P/E) ratio of 16.5 although the stock is up 98% this year. Trinity's forward P/E is 12.1 after a gain of 61% this year, while Wabtec has a forward P/E of 19.8 after a 9.8% gain.

In terms of return on equity over the past 12 months, Greenbrier's ROE is 18.9%, Trinity's is 23.1%, and Wabtec's is 19.9%. Greenbrier doesn't pay a dividend, but Trinity and Wabtec offer slim yields of 0.9% and 0.3%, respectively.

Risks To Consider: Unexpected approval of the Keystone XL pipeline and similar pipeline proposals by the White House could reduce surging shale energy shipments by rail, as could new environmental restrictions on fracking. If Republicans gain control of both houses of Congress in November, some government regulations forcing massive safety and equipment upgrades could be rolled back. The rail industry is intensely sensitive to the economic cycle, and a slowdown or renewed recession would have a direct impact on these stocks.

Action To Take --> Go long any or all of GBX, TRN and WAB. Wall Street is taking a positive view of all three: The First Call consensus of more than 10 analysts for each stock is a "buy," and Capital IQ is bullish on all three from a technical viewpoint.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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This article appears in: Investing , Investing Ideas , Stocks

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