Lately, I have been exploring companies that should benefit the most from the continuing economic recovery and the various activities that go along with it. Examples of what will occur if the recovery continues include increased manufacturing and construction activity, and a sector that will benefit greatly from both is the transportation industry, specifically railroads. Having lived in the Southeast for my entire adult life, the railroad company whose operations I am most familiar with is CSX Corporation (NYSE:CSX), so we’ll start there and then see how they compare to some of their competitors.
CSX’s Business
CSX Corporation (NYSE:CSX)’s rail network is the largest in the eastern U.S., operating in 23 states and Canada with over 21,000 miles of track. The majority of the company’s revenue comes from four sources.Coal shipments account for 27% of CSX’s total revenue and mostly include deliveries to utility companies. Merchandise freight accounts for almost half of CSX Corporation (NYSE:CSX)’s revenues, and major products are chemicals, forest products, and metals. Automotive freight makes up another 10%, and the rest of CSX’s shipments are classified as “intermodal transport,” which means transporting freight using one container for a variety of shipping methods (rail, ship, truck), an example of which is shown below.
Growth and Valuation
While the economic recovery won’t necessarily help things like coal revenue, the merchandise freight business (CSX’s largest revenue stream) stands to benefit greatly, as most of what they ship has to do with the two things mentioned earlier: manufacturing and construction. Additionally, as a result of the recession, railroad companies have taken steps to improve the efficiency of their business, which has resulted in return on invested capital nearly doubling from 8.7% to 16.6% since 2005.
CSX Corporation (NYSE:CSX) trades for just 13.2 times TTM earnings, which sounds like a bargain, especially considering the recovery-driven earnings growth that is expected over the next few years. The company is expected to earn $1.78 per share this year, rising to $2.02 and $2.28 in 2014 and 2015, respectively, for annual earnings growth of 13.5% and 12.9%. Additionally, CSX has a great track record of increasing shareholder value through both dividends and buybacks. Shares currently yield 2.42% and the company has raised the payout consistently over the past several years. The company’s buyback program is even more impressive, with the total number of shares dropping by about 14% since 2009.
Competitor on the East Coast: Norfolk Southern
As the heading implies, Norfolk Southern Corp. (NYSE:NSC) operates in the same territory as CSX Corporation (NYSE:CSX) and is just a bit smaller in terms of rail network. Norfolk Southern Corp. (NYSE:NSC) pays a slightly higher (2.65%) yield than CSX, but trades at a slightly higher P/E of 13.6 times TTM earnings, with similar growth expectations. When it comes to Norfolk Southern Corp. (NYSE:NSC) and CSX, it is a coin flip, but I give the slight edge to CSX Corporation (NYSE:CSX) due to shares being just a little cheaper.
West Coast Giant: Union Pacific
Union Pacific Corporation (NYSE:UNP) is a much larger company, almost three times the size of CSX by market cap. Union Pacific Corporation (NYSE:UNP) operates more than 32,000 miles of rail in the western United States. Although Union Pacific Corporation (NYSE:UNP) is the largest, it is also the lowest yielder (1.77%) and the most expensive at 18.3 times TTM earnings. However, it is expected to be the greatest beneficiary of such trends as increased crude oil shipments and more automobiles shipped west, and earnings are projected to climb by 15.1% this year and 14.4% next year, slightly above peers.
Buy, Sell, or Hold?
Union Pacific Corporation (NYSE:UNP) seems to be a bit expensive right now, but the other two companies are very reasonably valued relative to their projected growth. CSX Corporation (NYSE:CSX) should benefit greatly from manufacturing and construction gains over the next few years, and longer-term should benefit from increased shipments of coal, the demand for which is historically low right now.
The article This Company Will Grow its Profits in the Recovery originally appeared on Fool.com.
Matthew Frankel has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Matthew is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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