Companies that operate in the industrial sector of the market are highly dependent on the overall economy. Nowhere is this more apparent than in the railroad industry, where volumes and rates are very closely tied to the swings of economic activity. As the U.S. economy took a nosedive in 2008 and 2009, so did the financial fortunes of the nation's railroads, including Norfolk Southern (NSC 0.75%), CSX Corp. (CSX 0.83%), and Union Pacific (UNP 1.12%).
Now that the United States is several years removed from the heart of the financial crisis, business is showing undeniable signs of improvement for the nation's railroads. In turn, they reward shareholders with reliable growth and solid dividends. As a bonus, Norfolk Southern, CSX, and Union Pacific are still reasonably valued, meaning the investment case for the nation's railroads is still compelling.
Why railroads are great businesses
The railroad industry can take pride in the fact that one of the world's most famous investors, Warren Buffett, is a huge fan. His conglomerate Berkshire Hathaway purchased Burlington Northern Santa Fe for more than $26 billion in 2009.
Buffett's long-term proposition then, as it is now, is that high fuel costs would shift business away from the trucking industry and toward railroads. Moreover, as commercial activity in the United States normalized following the worst recession in decades, the railroads would be one of the first industries to recover. Those factors are still largely true when it comes to Norfolk Southern, CSX, and Union Pacific.
It's plain to see the progress made by the railroads as 2013 draws to a close. Pricing gains and shipment volumes are showing improvement for the railroads, resulting in improving core metrics. And, as an added tailwind heading into next year, coal is no longer the huge drag on results that it had been for most of the year. For example, Norfolk Southern saw revenues increase fractionally, but thanks to accretive share buybacks, earnings per share are up 8% through the first nine months of the year.
Meanwhile, CSX's revenues increased 2% through the first nine months, and earnings per share rose 5% in the same period. For the full year, CSX expects to increase earnings per share as opposed to 2012. Lastly, Union Pacific's performance leads the pack. Its revenue and earnings per share are up 4% and 13%, respectively, year-to-date. Coal freight revenues were actually up 2% in the most recent quarter.
Not only are railroad investors receiving the benefit of improving business conditions, but the railroad stocks are also generous with returning cash to shareholders. Norfolk Southern, CSX, and Union Pacific offer yields that are competitive with the yield on the broader market, and each stock raised its dividend in 2013.
Valuations remain attractive
Assuming steady recovery in the U.S. economy, as well as any improvement in the coal market going forward, next year should be another year of growth for Norfolk Southern, CSX, and Union Pacific. Adding to the merits of railroad stocks is the fact that they're still modestly valued, especially when compared to the broader market. After its impressive rally in 2013, the S&P 500 Index trades for a trailing price-to-earnings ratio in the high teens. Norfolk Southern, CSX, and Union Pacific each exchange hands for 18 times trailing earnings or less. In fact, CSX holds a particularly attractive valuation, at just 15 times trailing earnings.
As a result, value and growth investors should see a lot to like from the railroad stocks. Each of them are growing, and are back to reporting solid underlying results. As the U.S. economy slowly but surely recovers from the worst recession in decades, the railroads are getting back to health. Norfolk Southern, CSX, and Union Pacific each hold attractive valuations to boot, meaning investors looking for solid opportunities in 2014 should put the nation's railroads at the top of their lists.
