By Glory Apr, 28, 2020 Private

There are some investments that perform perfectly in the short-term while others yield better returns in the long-term, and investing in railroad stocks is one of such investments that perform better in the long-term.

Many investors who buy railroad stocks are simply in it for a long time. For such investors, the key to investing in railroad stocks is the lifetime of income from well-paying companies in the industry. There is no doubt that technology has revolutionized the transport industry, However, there would always be a need for railroads as long as physical goods need to be transported across America, especially North America.

In recent times, the railroad industry has undergone and is still undergoing some tremendous transformation that would benefit a lot of investors. Although this transformation comes along with a few short-term stock volatilities, its long-term earnings and growth prospects will be enhanced.

The railroad industry transformation is highly driven by precision scheduled railroading (PSR). The PSR is the single biggest earnings driver in the industry. There has also been a wide-scale adopting of the PSR by almost all the North American Class I railroads.

Precision scheduled railroading or PSR, as the name implies, is an operating methodology used to emphasize running trains operating between two points on a network and a fixed schedule. This methodology differs from the traditional hub-and-spoke which requires that rail cars enter a hub on one train, and are dispatched to their final stop point pulled by a different train.

In addition, there is a tendency that the management methodology used by PSR will most likely change the investment environment significantly. This is the major reason why companies like Union Pacific (NYSE: UNP), Kansas City Southern (NYSE: KSU), and Norfolk Southern (NYSE: NSC), that have recently adopted PSR are some of the best performing railroad companies that can benefit investors.

A major characteristic of the PSR is that it allows trains to run on fixed schedules, giving allowance to the sales and marketing staff of a company to adjust pricing so that they can maximize carload revenue and increase train length. Also, there is a low chance of rail cars mismatch at two ends of the network.

In a nutshell, PSR helps railroad companies improve profitability and asset utilization. Hunter Harrison, developer of the PSR was able to create the system by making significant improvements in the operating ratios (ORs) of the Canadian National Railway (NYSE: CNI) and Canadian Pacific Railway (NYSE: CP). The OR is still commonly used in the railroad industry as a metric. It is represented by expenses divided by revenue.

This OR development by Harrison led to the creation of the PSR which has become widely adopted in the railroad industry. A good number of the largest railroads in North America use PSR.

“PSR is a set of management principles based on running freight on fixed scheduled trains on a point-to-point basis rather than the traditional hub-and-spoke model.” (Nasdaq)

Why Invest in Railroad stocks?

The railroad industry is one of the most important aspects of the US economy. This sector can be said to play an important role in the economic growth of the US. Railroad companies are majorly responsible for the transportation of raw materials, agricultural produce, commodities, electronics, and other heavy or bulk goods from one point to another.

Railroad stocks are represented by the SPDR S&P Transportation ETF (XTN). Before now, these stocks had underperformed the broader market. Collectively, they generated a total return of -39.4% compared to the S&P 500’s total return of -17.6% in the past twelve months.

Like many long-term stocks, railroad stocks have the potentials to yield significant returns for the investor. However, investors must note that the railroad industry’s revenue tends to fluctuate in line with the economy from time to time. With this in mind, it would be a good idea to approximate what the average earnings margin could be over a long period of time.

Contrary to the current economic decline caused by the coronavirus pandemic, The Class 1 railroads have experienced an unusual earnings season. Some analysts expected that the railroad industry would underperform in such times—it would have been totally understandable.

Early this year, the CSX, Norfolk Southern and Kansas City Southern, all notable outperformed the S&P 500 index. There is a possibility of this continuing considering that these railroad companies have adopted the PSR operating method. By using PSR, railroad companies aim to improve metrics like train velocity and terminal dwell i.e. the amount of time a car spends at a terminal location.

The performance results of these railroad companies demonstrate evidential profitability that the industry is doing well in spite of the current economic situation. It also suggests that the industry could continue to generate more profits regardless of the declining revenue. Railroads have experienced good stock performance in recent times.

Top US-based stocks

BNSF Railway Company: BNSF is the largest freight railroad network in North America. It is a Texas-based Class I railroad company, covering 32,500 miles (52,300 km) in 28 states, and over 8,000 locomotives. It has three major transcontinental routes that connect the western and eastern United States. The BNSF Railway Company is a subsidiary of the Burlington Northern Santa Fe, LLC, its parent company which is also a subsidiary of Berkshire Hathaway, Inc. BNSF is among the top intermodal freight transporters in North America. It transports bulk cargo, including bulk coal which makes up about 10% of the electricity produced in the US.

Union Pacific Corporation: Union Pacific is the second-largest public railroad based on revenue, closely following BNSF of Berkshire Hathaway. The company has the Union Pacific Railroad as its principal company, covering 23 states across the western United States. The company has since invested $35 billion in its network and operations to support America’s transportation. It is also engaged in a diversity of businesses through its Bulk, Industrial, and Premium business groups.

CSX Corporation: CSX is an American holding company engaged in rail transportation and real estate in North America. It was established as part of the Chessie System and Seaboard Coast Line Industries merger in 1980. The railroads of the former Chessie Systems and Seaboard Coast Line Industries were later merged into a single line owned by CSX Corporation in 1986; it then became CSX Transportation. CSX Transportation is a Class I railroad operating in the eastern United States and Canadian provinces of Quebec and Ontario, covering 21,000 miles (34,000 km) across 23 states in the US.

Best International and Domestic Railroad Stocks for Q2 2020

We have outlined below top railroad stocks based on the best value, fastest growth, and most momentum.

1. Top best value railroad stocks: the lowest 12-month trailing price-to-earnings (P/E) ratio. A low P/E ratio would allow investors to pay less for each dollar generated because investors can be paid profits in the form of dividends or buybacks.

Source: YCharts

Central Japan Railway: Central Japan Railway Company is a railway service provider company based in Japan. The company provides three major railroad services; transportation, distribution, and real estate. The Transportation unit operates in Tokaido Shinkansen railways and the railways in the Tokai area; it also provides bus services. The Distribution unit operates in department stores in JR central towers, also merchandising business in train compartments and train stations. While the Real Estate unit deals with the leasing and sale of station buildings and other real estates in general. In addition to its railroad services, the company is also engaged in manufacturing of railway vehicles, provision of maintenance and repair services for different equipment, advertising, tourism, and hotel business.

Greenbrier Companies: The Greenbrier Companies Inc. is a designer, manufacturer, and marketer of railroad freight car equipment company located in North America, South America, and Europe. The company was incorporated on October 25, 2005. Since its incorporation, the company has since expanded its reach beyond the US borders and has grown significantly. It manufactures railcars in Brazil and marine barges in North America. It is a major provider of freight railcar wheel services, spare parts, repair, and refurbishment in North America. The company operates in three major segments: manufacturing, wheels, repairs & parts, and leasing & services. The manufacturing segment is engaged in operating from the United States, Mexico, Romania, Turkey, and Poland. It is focused on producing double-stack intermodal railcars, conventional railcars, automotive railcar products, marine vessels, and tank cars. It’s Wheels, Repair & Parts segment is engaged in the repair, maintenance, and refurbishment, as well as the manufacturing of parts for railcars. While the Leasing & Services segment is engaged in leasing out railcars to clients. In August 2018, this segment had approximately 8,100 railcars in its possession. 6,300 railcars out of the total number were held as equipment on operating leases, while 1,600 railcars were held as leased railcars for syndication and the remaining 200 held as finished goods inventory. This segment also provides services to about 357,000 railcars for railroads, shippers, institutional investors like banks, and other leasing transportation companies based in North America.

West Japan Railway: The West Japan Railway Company is a Japan-based company that mainly provides passenger railway transportation services. The company, generally, operates in three segments: Transportation, Distribution, and Real Estate. The Transportation segment is engaged in the provision of ferry and bus transportation services. The Distribution segment deals with the operation of department stores, catering business, sale of goods, wholesale, and logistics business. While the Real Estate segment is engaged in the leasing and sale of real estate properties the company owns, and the operation of shop centers. The Company also has other businesses it operates, such as hotel, construction, and others.

2. Top fastest growing railroad stocks: These are the top railroad stocks with the highest YoY earnings per share (EPS) growth for the most recent quarter. High or increasing earnings tell that a company is on a steady growth towards generating more money that it can distribute as dividends among shareholders or reinvest back into the business.

Source: YCharts

Westinghouse Air Brake Technologies: Wabtec Freight Cars Pneumatics is a unit of Westinghouse Air Brake Technologies Corporation (Wabtec), a top global provider of products and services for the freight railroad and passenger transit industries. Wabtec is the only company in North America that offers a variety of components and products, ranging from control values to draft gears, brake shoes, articulated couplings of Eng-of-Train devices. The company basically provides an exhaustive list of product line products in the railroad industry. Wabtec is engaged in two main segments: The Freight segment which includes locomotive, freight car, PTC signaling wayside, power generation, and industrial; and the Transit segment which includes transit car and transit buses.

Canadian Pacific Railway (CPR): The Canadian Pacific Railway (CPR) is a Canadian Class I railway incorporated in 1881, located in Calgary, Canada. The company owns approximately 20,100 kilometers (12,500 mi) of track covering all Canadian regions and extending into the United States. It stretches from Montreal to Vancouver, Quebec, British Columbiana, and Edmonton. Also Minneapolis-St. Paul, Milwaukee, Detroit, Chicago, and New York City in the United States. The railway company is engaged in providing transportation, logistics, and supply chain expertise all cross the regions it covers. It deals with the transportation of bulk commodities, merchandise freight, and intermodal traffic.

3. Top railroad stocks with the most momentum: These are the top selected railroad stock that made the highest total return over the past 12 months. Though two of the selected stocks are in the negative over the past year, they still made it to the top three performers amid the stock market crash in the past month.

Source: YCharts

Kansas City Southern: Kansas City Southern is a transportation holding company based in Missouri. It has investments in the United States, Mexico, and Panama. The company’s primary US holding is The Kansas City Southern Railway Company which serves the central and south-central US. It also has international holdings located in the northeast and central Mexico, port cities of Lazaro Cardenas, Tampico and Veracruz. The Kansas City Southern is engaged in providing railroad services to shippers within the US or Mexico or cross-border. The company offers customers seamless transportation throughout North America and beyond through their significant partnerships with Class I railroads, transload centers, and intermodal ramps, short line partners, etc.

Investing in railroad stocks are more preferred for long-term investors. Railroad stocks also provide income-seeking investors with a relatively safe way to get income with prospects of inflation-busting growth in dividends, making railroad stocks attractive to investors. Also, railroad stocks tend to perform well in the midst of economic growth and falling interest rates, however, they may not perform well in a rising rate environment even though it implies greater economic expansion.

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