Five Railroad Stocks to Buy Now (Before They Buy Each Other)

2015 was one of the worst periods for railroad stocks in many years. The heavy declines in the price of crude oil and coal, which are the largest cargo loads for the industry, took a heavy toll on the sector last year, causing many rail companies to post dismal financial numbers. This poor performance was reflected by their stock prices, which were on a consistent decline throughout the year. The underperformance of the sector can be gauged from the returns of the Dow Jones U.S. Railroads Index, which ended 2015 down by over 30%. In comparison, the broader market suffered only a marginal decline during that time. Though the sector began 2016 with declines too, it suddenly changed its trajectory a few weeks ago and has been rallying since then. The Dow Jones U.S. Railroads Index is currently trading up by over 25% from its 52-week low of $879.01, which it hit on January 25, and now boasts year-to-date gains of over 6%. Taking into account that the sector is showing signs of positive momentum, we at Insider Monkey though it might be the right time to come up with a list of railroad stocks based on their popularity among the hedge funds that we track heading into this year. In this article we’ll disclose and analyze the five stocks that made it to the top of our list.

We track prominent investors and hedge funds because our research has shown that historically their stock picks delivered superior risk-adjusted returns. This is especially true in the small-cap space. The 15 most popular small-cap stocks among a select group of investors delivered a monthly alpha of 80 basis points between 1999 and 2012 (see the details here).

#5 Canadian Pacific Railway Limited (USA) (NYSE:CP)

  – Investors with Long Positions (as of December 31): 29

 – Aggregate Value of Investors’ Holdings (as of December 31): $3.06 billion

Canadian Pacific Railway Limited (USA) (NYSE:CP) saw a significant drop in its popularity during the fourth quarter, with its ownership among funds covered by us declining by ten, while the aggregate value of their holdings in the stock fell by $914 million. However, it is the top railroad stock on this list in terms of the aggregate value of investors’ holdings at over $3 billion. In mid-November the company made a $28 billion bid for Norfolk Southern Corp. (NYSE:NSC), but the latter’s Board rejected that offer within a few days. Canadian Pacific Railway Limited (USA) came back with a revised buyout bid in December which was supported by activist investor Bill Ackman, whose fund Pershing Square owns 13.94  million shares of Canadian Pacific Railway Limited (NYSE:CP) as of December 31, and who is also a member of its Board of Directors. After the company’s revised bid was again rejected by Norfolk Southern Corp. (NYSE:NSC)’s Board, Canadian Pacific’s CEO said that the company won’t shy away from taking its revised bid to a proxy fight. However, the company said last month that it doesn’t want to engage in a proxy fight with Norfolk Southern Corp.’s Board. Since the deal is facing opposition from several quarters, Canadian Pacific Railway Limited (USA)’s CEO revealed in an interview on March 17 that the company is likely to hike its dividend or buy back its stock if its takeover attempt of Norfolk Southern Corp. fails to materialize.

#4 Norfolk Southern Corp. (NYSE:NSC)

 – Investors with Long Positions (as of December 31): 32

 – Aggregate Value of Investors’ Holdings (as of December 31): $513.16 million

Despite being a takeover target, as discussed above, the ownership of Norfolk Southern Corp. among investors covered by us inched down by one during the fourth quarter. However, the aggregate value of investors’ holdings in the stock saw a slight increase of 3.6% during the quarter. Billionaire Israel Englander‘s Millennium Management increased its stake in the company by 130% to 844,351 shares during the fourth quarter and became its largest shareholder in our database. Shares of Norfolk Southern Corp. fell by over 17% in January, but have recovered since and are currently trading flat for the year. Norfolk Southern Corp. pays a quarterly dividend of $0.59 per share, which translates into a respectable annual dividend yield of 2.81%. On March 17, analysts at Scotiabank initiated coverage on the stock with an ‘Outperform’ rating.

The top three railroad stocks to buy now are disclosed on the following page.

#3 Kansas City Southern (NYSE:KSU)

  – Investors with Long Positions (as of December 31): 34

 – Aggregate Value of Investors’ Holdings (as of December 31): $986.38 million

Amid a 17.8% decline in its stock during the fourth quarter, the number of investors in our system with long positions in Kansas City Southern (NYSE:KSU) decreased by six and the aggregate value of their holdings in it declined by $462 million. Jonathon Jacobson‘s Highfields Capital Management was one of the hedge funds that initiated a stake in the company during that period, purchasing 1.68 million shares. Though shares of Kansas City Southern (NYSE:KSU) have appreciated by almost 18% so far this year, some analysts believe that they are still undervalued, considering that the stock has been an outperformer for many decades. According to Agora Financial, Kansas City Southern has been the best-performing stock in the last 42 years, delivering an annualized return of 26% during that period. Furthermore, despite the slowdown in the railroad industry, Kansas City Southern has been performing relatively well compared to its peer group. On March 2, analysts at Cowen and Company reiterated their ‘Market Perform’ rating on the stock, but upped their price target on it to $88 from $76.

#2 CSX Corporation (NASDAQ:CSX)

 – Investors with Long Positions (as of December 31): 45

 – Aggregate Value of Investors’ Holdings (as of December 31): $1.05 billion

Moving on, ownership of CSX Corporation (NASDAQ:CSX) among the hedge funds that we follow inched down by two and the aggregate value of their holdings in it declined by $343 million during the fourth quarter. A notable fund which reduced its stake in the company during that period was James Dinan‘s York Capital Management, which cut its holding by 37% to 32.87 million shares. Shares of CSX Corporation (NASDAQ:CSX) have rallied significantly this month after it came to light on March 1 that Canadian Pacific Railway held takeover talks with the company in January. Owing largely to this rally, shares are currently trading up by 3.9% year-to-date. Citigroup analyst Christian Wetherbee, who previously estimated that CSX Corporation could be valued in the low-$40 per share range in a takeover bid, recently revealed in a note to clients that the company will possibly be acquired if a bid valuing it in the ‘upper $30s’ per share range is made. Shares currently trade at $26.66, which suggests a potential deal could reward shareholders with about 40% gains. Mr. Wetherbee also feels that CSX Corporation is “a somewhat better strategic fit” for Canadian Pacific Railway than Norfolk Southern Corp.

#1 Union Pacific Corporation (NYSE:UNP)

 – Investors with Long Positions (as of December 31): 56

 – Aggregate Value of Investors’ Holdings (as of December 31): $1.98 billion

Union Pacific Corporation (NYSE:UNP) was not only the most popular railroad stock among hedge funds covered by us as of the end of the fourth quarter but was also the only stock in this list which saw a rise in its popularity during that period. The number of investors tracked by Insider Monkey with long positions in Union Pacific Corporation (NYSE:UNP) inched up by one and the aggregate value of their holdings in it jumped by $471 million during the October-to-December period. Most analysts share the same sentiment on the company as hedge funds. They believe that Union Pacific Corporation is one of the most stable stocks in the railroad sector and that given the kind of cashflow the company generates, its annual dividend yield of 2.62%, and its relatively low forward P/E of 14.04, its stock is poised to move higher in the coming quarters.  D.E. Shaw, founded by billionaire David E. Shaw, increased its stake in the company by 668% during the December quarter.

Disclosure: None