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Railroad Stocks Look Attractive at Current Prices

Contrary to the demise of coal usage, the railroad stocks are not dead yet.  The road and rail industry has trailed the S&P 500 in performance throughout 2012.  However, my analysis indicates that the rail stocks are undervalued and should be considered as a buy.  Last week, Goldman Sachs issued this report:

Goldman Sachs resumed coverage of the U.S. transportation sector with an attractive coverage view on railroads.   Canadian Pacific Railway (CP) was a top buy idea and made it to the conviction list. Goldman gave a buy rating to CSX Corp. (CSX) and Norfolk Southern Corp. (NSC).  The U.S. transportation industry still has room to raise rates further to recoup years of economic losses, said in a note.

I am in disagreement with Goldman on CP.  While CP is a good company, it is priced to high with a PE of 18 for a growth rate of 10%.  CP has a 5-year average PE of 14 which is comparable to the current industry average of 13.78.  If you like CP, wait for a pullback in price before entering.

My favorite rail stocks at this time are Norfolk Southern (NSC) and CSX Corp (CSX).  They both trade at a PE of around 12 which is lower than the industry average of 13.78.  NSC is trading at $72.25.  Medium-term trends in the majority of NSC’s markets remain favorable and support rising traffic, in our opinion. We see investments in its network improving capacity on heavily trafficked lanes like the Heartland and Crescent corridors, and leading to greater conversion of truck traffic over to rail.  Coal shipments will be down but the growth in other areas will overshadow its impact.  NSC has a 3-5 year projected growth rate of 13.8%.  NSC has a current dividend yield of 2.58% which compounds at 16.4% annually.  Looking forward 10 years, NSC will have a yield on cost of 11.9%.  NSC has an equity summary score of 9.0 out of 10 for a Bullish outlook.

CSX is trading at $21.89 with a one year price performance of -12.2%.  We believe CSX will benefit from economic recovery in the U.S., given its role in transporting many of the basic materials required in manufacturing and construction. We also think the recession forced a more intense focus on operating efficiencies, which should support wider margins during a period of rising volumes. CSX has a 3-5 year projected growth rate of 12.5%.  CSX has a current dividend yield of 2.50% which compounds at 15% annually.  Looking forward 10 years, CSX will have a yield on cost of 9.9%.  CSX has an equity summary score of 7.5 out of 10 for a Bullish outlook.

Union Pacific (UNP) is a little more expensive at a PE of 14 but it also has an EPS growth rate of 15%.  We believe UNP’s new traffic, especially shale-oil related, is coming on at higher prices than we had previously anticipated. On this, and slightly improved coal volumes, we are boosting our EPS estimate for ’12 by $0.24 to $8.19 and ’13’s by $0.22 to $9.02. We note that UNP posted Q2 EPS of $2.10, vs. $1.59, exceeding our estimate and the Capital IQ consensus, both of which were $1.96.  UNP is trading at $117.37 with a dividend yield of 2.01%.  Looking forward 10 years, UNP will have a yield on cost of 7.9%.  UNP has an equity summary score of 9.3 out of 10 for a VERY Bullish outlook.

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