Zacks Equity Research discusses Canadian National Railway Co. CNI, CSX Corp. CSX and USD Partners LP USDP.

Prospects of Zacks Transportation – Rail industry’s participants are being dented due to challenges like inflation-induced high-interest rates, weak freight rates and supply-chain disruptions.

Despite the challenges surrounding the industry, Canadian National Railway Co., CSX Corp. and USD Partners LP appear better placed to tide over the challenges. Declining fuel costs represent a tailwind as far as bottom-line growth is concerned.

Industry Description

The Zacks Transportation – Rail industry includes railroad operators transporting freight (such as agricultural products, industrial products, coal, intermodal, automotive, consumer products, metals and minerals), primarily across North America. These companies focus on providing logistics and supply-chain expertise services.

While freight constitutes a significant chunk of revenues, some of these companies also derive a small portion of their top line from other rail-related services, including third-party railcar and locomotive repairs, routine land sales and container sales, among others. A few companies offer service to multiple production and distribution facilities. Besides locomotives, some of these companies own equipment of leased locomotives, railcars etc.

Factors Deciding the Industry’s Outlook

Decline in Oil Price is a Tailwind: The decline in expenses on fuel represents another tailwind for the industry. Notably, oil prices declined 6.6% in the April-June period. As fuel expenses represent a key input cost for any transportation player, the fall in oil prices bodes well for the bottom-line growth of railroad stocks.

Dividend Hikes Signal Financial Bliss: With the resumption of economic activities, many players, including some railroad companies, are reactivating shareholder-friendly measures like paying out dividends, which underline their solid financial footing and confidence in the business. For example, in 2023, CSX raised its dividend by 10% to 11 cents per share.

Economic Uncertainty Continues:  Although favorable symptoms of easing inflation have brought some relief to U.S. stock markets, the recent rate hike remains a concern. The Fed reinitiated its interest rate hike process in the July FOMC meeting after taking a breather in June. On Jul 26, 2023, the Fed raised the benchmark lending rate by 25 basis points to the range of 5.25%-5.50%. This marked the highest range of the Fed fund rate since March 2001.

Risks associated with an economic slowdown, geopolitical tensions and supply-chain woes dampen the prospects of stocks belonging to this industrial cohort. Due to the uncertainty, the Cass Freight Index declined 1.6% on a month-on-month basis in June 2023. In fact, the index has declined month on month in four out of the first six months of the year. The slowdown in freight demand does not bode well for railroad operators.

Zacks Industry Rank Indicates Gloomy Prospects

The Zacks Railroad industry, housed within the broader Zacks Transportation sector, currently carries a Zacks Industry Rank #222. This rank places it in the bottom 12% of more than 250 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates dull near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

The sell-side analysts covering the companies in this industry have been decreasing their estimates. Over the past year, the industry’s consensus earnings estimate for the current year has decreased 11.3%.

Despite the cloudy prospects, we present a few stocks that investors can retain given their sturdy potential. But before that let’s take a look at the industry’s recent stock market performance and its current valuation.

Industry Lags S&P 500 & Sector

Over the past year, the Zacks Transportation – Rail industry has declined 1.1% compared with the S&P 500 composite’s gain of 8.6% and the broader sector’s surge of 4.8%.

Industry’s Current Valuation

Based on the trailing 12-month price-to-book (P/B), a commonly used multiple for valuing railroad stocks, the industry is currently trading at 7.25X compared with the S&P 500’s 6.05X. It is also above the sector’s P/B ratio of 4.62X.

Over the past five years, the industry has traded as high as 10.86X, as low as 5.69X and at the median of 8.08X.

3 Stocks to Keep a Tab On

All three stocks mentioned below carry a Zacks Rank #3 (Hold).

Canadian National: Based in Montreal, Canada, Canadian National is involved in rail and related transportation business. CNI’s efforts to reward its shareholders via dividends and buybacks are encouraging and highlight the company’s financial strength. In January, the company announced an 8% dividend hike. Strong cash flow generating-ability supports Canadian National’s shareholder-friendly activities. The company is also benefiting from higher export volumes of Canadian grain.

CNI has an encouraging track record with respect to earnings surprises. The company surpassed the Zacks Consensus Estimate for earnings in two of the last four quarters (missing the mark in the other two). The average beat is 2.52%.

CSX: Based in Jacksonville, FL, CSX offers rail-based freight transportation services like traditional rail service, transport of intermodal containers and trailers apart from rail-to-truck transfers.

CSX’s top line is benefiting from higher volume growth in coal and merchandise and solid gains in merchandise pricing. CSX is trying to drive growth by reducing operating expenses. Efforts to reward its shareholders also bode well. CSX has a stellar track record with respect to earnings surprises. The company surpassed the Zacks Consensus Estimate for earnings in each of the past four quarters, with an average beat of 6.17%.

USD Partners: Based in Houston, TX, USDP acquires, develops, and operates midstream infrastructure assets and logistics solutions for crude oil, biofuels, and other energy-related products in the United States and Canada.

USDP has an encouraging track record with respect to earnings surprises. The company surpassed the Zacks Consensus Estimate for earnings in two of the past four quarters (missing the mark in the other two). The average beat is 64.77%.
CSX Corporation (CSX): Free Stock Analysis Report

Canadian National Railway Company (CNI): Free Stock Analysis Report

USD Partners LP (USDP): Free Stock Analysis Report

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Zacks Investment Research

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