What Does Billionaire Ken Griffin’s Citadel See In Norfolk Southern Corp. (NSC)?

In May, billionaire Ken Griffin’s Citadel Investment Group filed its 13F for the first quarter of 2013, disclosing many of its long positions in U.S. stocks as of the end of March. We track 13Fs from hundreds of hedge funds, primarily as part of our work developing investment strategies (we have found, for example, that the most popular small cap stocks among hedge funds earn an average excess return of 18 percentage points per year). However, we also like to look for significant changes in funds’ filings. When we looked at Citadel’s most recent 13F, we noticed that it had increased its stake in railroad Norfolk Southern Corp. (NYSE:NSC) to a total of 2.6 million shares from a very small position at the beginning of the year (see more of Griffin’s stock picks).

While Norfolk Southern reported an increase in its earnings in the first quarter of 2013 versus a year earlier, this looks to have been driven by income not related to the company’s core operations. Actual operating income declined by 7%, with revenue falling slightly as well. There have been some share repurchases over this time frame, and cash flow from operations has certainly been high enough to cover both capital expenditures and Norfolk Southern Corp. (NYSE:NSC)’s moderate dividend yield (though CFO also came in lower than a year ago), but still we’d be somewhat concerned that the railroad has not been performing well.

The stock is not priced for much growth, however, with its current valuation resulting in a trailing earnings multiple of only 14. That pricing would incorporate future earnings per share growth, but it’s possible that continued buybacks could make Norfolk Southern Corp. (NYSE:NSC) about fairly valued if business is about flat. Wall Street analysts are looking for EPS to increase over the next year and a half, and it looks to be at a rapid enough rate that the company would in fact have to grow its net income as well as supplement its earnings through repurchases. Michael Karsch’s Karsch Capital Management initiated a position of 1.6 million shares in Norfolk Southern between January and March, making the stock its largest single-stock holding (find Karsch’s favorite stocks).

Other large publicly traded railroads include Union Pacific Corporation (NYSE:UNP) and CSX Corporation (NYSE:CSX). CSX is in a somewhat similar situation to that of Norfolk Southern: revenue and earnings showed little change in its most recent quarter compared to the same period in the previous year, though the market’s expectations for the company are low going by the trailing P/E of 14. That’s even with where Norfolk Southern Corp. (NYSE:NSC) was trading, and given its recent performance CSX isn’t that exciting to us. Union Pacific has been doing better, recording decent growth on both top and bottom lines. However, the $73 billion valuation already incorporates a good deal of future growth as the stock’s trailing and forward earnings multiples come out to 18 and 14 respectively.

We can also compare Norfolk Southern Corp. (NYSE:NSC) to Kansas City Southern (NYSE:KSU) and to Genesee & Wyoming Inc (NYSE:GWR). These companies carry premium valuations to their peers, possibly as investors speculate that they could be acquisition targets for a public competitor or Berkshire Hathaway’s Burlington Northern Santa Fe. Kansas City Southern’s trailing and forward P/Es are both over 20, and while net income was up strongly last quarter compared to the first quarter of 2012 revenue grew only 1% and so we’d doubt that high earnings growth is sustainable. The most recent quarterly report from Genesee & Wyoming was quite strong, with large percentage increases in revenue and earnings. However, with a valuation of 44 times trailing earnings we’d hold off on buying at least for now.

The railroad industry in general doesn’t seem to be a great opportunity right now. Citadel, and other investors in Norfolk Southern Corp. (NYSE:NSC), are apparently counting on the company managing to turn around its weak performance from the first quarter of this year. We suppose that if the business can do so, it would make for a value opportunity given that the market is expecting more or less flat numbers going forward. However, we wouldn’t want to depend on management delivering earnings growth and so we’d avoid the stock- as we would its peers, though Genesee & Wyoming Inc (NYSE:GWR) could end up being a growth stock if it continues to experience strong growth in the next quarter or two.

Disclosure: I own no shares of any stocks mentioned in this article.