Many of the U.S.-based publicly traded railroads are suffering from extremely tough operating conditions, and there’s only one culprit: coal. Due to a variety of factors including depressed natural gas prices and a broader national desire for cleaner sources of energy, railroads are shipping significantly reduced levels of coal and realizing lower prices to boot. This has brought down bottom lines across the industry, and it makes investing in railroads an iffy proposition.
Are any domestic railroads that are worth buying despite coal’s drag on profitability, or would investors be better served remaining on the sidelines until coal fundamentals improve?
Norfolk Southern Corp. (NYSE:NSC) relies on coal for approximately 22% of its operating revenue, and the company’s sluggish results exemplify the dour situation facing coal.
Coal revenues dropped 17% in both the most recent quarter and the first six months of the year for Norfolk Southern Corp. (NYSE:NSC), offsetting strength in the company’s General Merchandise and Intermodal segments. Overall, Norfolk Southern Corp. (NYSE:NSC)’s quarterly revenue fell 3% year over year, despite coal being the only operating segment to see a decline in revenue during the quarter.
For its part, CSX Corporation (NYSE:CSX) is holding steady. The company’s second-quarter revenues were flat year-over-year, while diluted earnings per share managed a 6% increase.
Coal is very important for CSX Corporation (NYSE:CSX) as well, however, as it accounts for one quarter of the company’s revenue. Over the first six months, CSX Corporation (NYSE:CSX) has seen its coal volume and revenue drop 8% and 9%, respectively.
Going forward, CSX Corporation (NYSE:CSX) is not overly optimistic about coal as it has noted the pronounced global oversupply as a likely headwind in future quarters. As a result, CSX Corporation (NYSE:CSX) investors should monitor the company’s coal results closely.
A clear outperformer
Union Pacific Corporation (NYSE:UNP), meanwhile, is not only hanging on through this tough environment — it’s thriving. The company’s fiscal second quarter produced record diluted earnings per share, operating revenue, and operating income. In all, operating revenue and diluted EPS climbed 5% and 13%, respectively.
Most surprisingly, though, Union Pacific Corporation (NYSE:UNP) grew freight revenue in four of its six segments. This included coal, which saw a freight revenue increase 12% in the second quarter. Second-quarter volumes actually fell 1%, which means that Union Pacific Corporation (NYSE:UNP) boasts exemplary pricing power.
Union Pacific Corporation (NYSE:UNP)’s uniquely reliable performance has earned its shares a noticeable premium to those of its industry peers. Whereas Norfolk Southern Corp. (NYSE:NSC) and CSX trade for 13 times trailing earnings, Union Pacific Corporation (NYSE:UNP) changes hands for 17 times trailing earnings. Investors shouldn’t let this well-deserved multiple scare them away from the stock.
Should investors ride the rails?
There’s no denying the impact coal is having on the nation’s railroads, and no guarantee that the current unfriendly economics of coal will reverse anytime soon. That said, as natural gas experiences rising demand, its price probably won’t stay this low forever.
At the same time, these railroads have demonstrated a remarkable ability to remain strongly profitable and reward shareholders, even with coal bringing down their results.
Therefore, while further share price gains may not materialize in the short term, these stocks should reward shareholders with resilient profits and strong dividends provided you keep a long-term perspective.
In that light, the compelling dividends and reasonable valuations make the railroad industry intriguing. Each of these stocks deserves a closer look for long-term Fools, with Union Pacific Corporation (NYSE:UNP) earning highest praise among the three.
The article Can U.S. Railroads Prosper in Spite of Coal? originally appeared on Fool.com and is written by Bob Ciura.
Robert Ciura has no position in any stocks mentioned. The Motley Fool owns shares of CSX.
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