Stocks in the railroad space are on a solid footing aided by factors like robust freight activity in the United States, impressive growth of the intermodal segment, reduced tax rates and prudent cost management.
Courtesy of the aforementioned factors, the Zacks Rail industry has outperformed both the S&P 500 index and the broader Zacks Transportation sector so far this year.
The stocks in this industry have collectively rallied 13.9% compared with the S&P 500's gain of 3.1% and the sector's decrease of 4.8%.
Let's examine in details the factors responsible for the optimism surrounding railroads.
Strong Economy & Upbeat Freight Demand
The thriving U.S. economy has resulted in an uptick in rail shipments of goods across the United States, like it usually does. It is no secret that the development of an economy is associated to a large extent with mobility of both goods and people.
The buoyant scenario is evident from the fact that the U.S. GDP grew 3.2% (on average) in the first three quarters of 2018, above the annual growth target of 3%. The Congressional Budget Office expects the U.S. economy to grow 3.3% this year.
Economic growth and demand for freight are positively correlated. In fact, the Cass Freight Shipments Index has expanded on a year-over-year basis in each of the 10 months of 2018. With high freight demand, the industry clearly stands to gain.
Intermodal revenues have also grown impressively this year. In fact, third-quarter intermodal volumes rose 4.7% year over year. Intermodal volumes had grown 7.2% and 6.2% in the first and second quarters of 2018, respectively. Strong intermodal volumes have been bolstering railroads' top line and the uptrend is likely to continue going forward.
Further, railroad operators' sustained cost-reduction efforts are anticipated to drive the bottom line going forward. Improvement pertaining to a key metric - operating ratio (operating expenses as a percentage of revenues) - is primarily attributable to the efforts of railroads to cut costs. The lesser the operating ratio, the better, as it implies that more cash is available to the company to reward shareholders through dividend hike or share buyback.
Moreover, the fact that railroads frequently indulge in the above-mentioned shareholder-friendly activities highlights their financial prosperity. In fact, the likes of Canadian National Railway Company CNI and Canadian Pacific Railway Limited CP have hiked their quarterly dividend payouts to the tune of 10% and 15.5%, respectively, this year.
A further increase in shareholder-friendly activities by railroads is likely in the wake of massive savings prompted by the current tax law (Tax Cuts and Jobs Act).
Moreover, the newly inked United States-Mexico-Canada Agreement is a positive for railroads especially the ones like Kansas City Southern KSU , which has significant Mexican exposure.
The Zacks Industry Rank of 26 (out of 250 plus groups) carried by the Zacks Rail industry further highlights the attractiveness of railroads. The favorable rank places the companies in the top 10% of the Zacks industries.
4 Railroad Picks
In view of the tailwinds mentioned above, we believe that it is prudent to add railroad stocks to one's portfolio now. Therefore, we have highlighted four stocks that may prove to be good buys. All these stocks carry a favorable Zacks Rank (#1 or 2) and have seen their share price and earnings estimates rise this year. You can see the complete list of today's Zacks #1 Rank stocks (Strong Buy) here.
A chart showing the share price movement of all the four stocks this year so far is given below.
CSX CorporationCSX is a premier transportation company providing rail, intermodal and rail-to-truck trans-load services and solutions. The stock sports a Zacks Rank #1. The Zacks Consensus Estimate for the current-year earnings per share has been revised 5% upward over the last 60 days.
Norfolk Southern CorporationNSC provides comprehensive logistics services and offers the most-extensive intermodal network on the eastern side of the United States. The stock carries a Zacks Rank #2. The Zacks Consensus Estimate for current-year earnings per share has been revised 1.2% upward over the last 60 days.
Union Pacific CorporationUNP is based in Omaha, NE. The company provides rail transportation services across 23 states in the United States. The stock carries a Zacks Rank #2. The Zacks Consensus Estimate for current-year earnings has been revised 0.8% upward over the last 60 days.
Canadian Pacific Railway Limited is the only transcontinental carrier with direct service to the U.S. eastern seaboard.The stock carries a Zacks Rank #2. The Zacks Consensus Estimate for current-year earnings has been revised 5.2% upward over the last 60 days.
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Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free reportCSX Corporation (CSX): Free Stock Analysis ReportUnion Pacific Corporation (UNP): Free Stock Analysis ReportCanadian Pacific Railway Limited (CP): Free Stock Analysis ReportKansas City Southern (KSU): Free Stock Analysis ReportCanadian National Railway Company (CNI): Free Stock Analysis ReportNorfolk Southern Corporation (NSC): Free Stock Analysis ReportTo read this article on Zacks.com click here.Zacks Investment Research