After dominating the markets for most of the last six months, the bull market’s early leaders have been showing signs of exhaustion lately, particularly the heavily tech-weighted indexes.
But it shouldn’t be unexpected to see large investors rotating from the best performers of the early bull market into overlooked or ignored equities.
In place of the increasingly out-of-favor cloud and cyber stocks, interest is picking up for under-the-radar opportunities in the industrial space, with the oft-ignored railroads among the stocks in this group showing the most promise.
Indeed, the unloved rails have come a long way since just over a year ago, when the U.S. Congress intervened to prevent a major rail worker strike. The drama surrounding the railroads has since died down, but more importantly, the sector has quietly shown some steady improvement across several key metrics in recent months.
Just last month, U.S. rail traffic was reported at nearly 475,000 carloads and intermodal units, up 4% year over year. Seven of the 10 carload commodity groups tracked by AAR have been posting year-on-year increases lately, including miscellaneous carloads, chemicals and motor vehicles and parts.
And after a slump in the auto industry in the last couple of years, analysts are forecasting stronger demand for 2024, which bodes well for auto transport (a major business for the railroads).
With this favorable backdrop in mind, here are some of the more attractive railroad stocks based on both technical and fundamental factors.
Norfolk Southern (NSC) is America’s fourth-largest railroad by revenue and transports a variety of raw materials, intermediate products, and finished goods across the U.S. The company has lately become the subject of high-profile activist investor drama. A group led by Ancora Holdings is calling for the ouster of Norfolk Southern’s current management and its replacement by a proposed new management team led by Jim Barber Jr. as CEO and turnaround expert Jamie Boychuck as chief operating officer. On that score, a major investment bank just upgraded the stock to “overweight” based on the firm’s belief that a management shakeup could lead to “notable” stock price gains. Analysts, meanwhile, see meaningful improvement to Norfolk Southern’s bottom line in the next couple of years as industrial demand continues to pick up steam.
Union Pacific (UNP) is the second-largest Class I railroad in the U.S. by revenue and is currently the largest publicly traded railroad stock. In recent months, Union Pacific has managed to impressively increase volume growth and core pricing while keeping operating expenses subdued despite inflationary pressures. In Q4, quarterly freight car velocity (a key metric) improved 14% from a year ago, and management just spoke at a major investment conference about what it sees as further opportunities to improve both car velocity and freight volumes in 2024. Wall Street is on board with the sanguine outlook and predicts 10%-ish earnings growth in each of the next three years, which is likely too conservative given economists’ forecasts for increased industrial and automotive production over that time frame.
Canadian National Railway (CNI) is focused on the rail, intermodal, trucking and marine transportation and logistics business in both Canada and the U.S. In both Q4 and 2023, Canadian National posted impressive on-time and velocity metrics, including full-year car velocity that was nearly 10% higher from 2022. Looking ahead, the company expects to deliver adjusted EPS growth of approximately 10% this year and expects to invest approximately C$3.5 billion in its capital program. Canadian National also expects return on invested capital to be within the targeted range of 15% to 17%. A 1.9% dividend yield is an added attraction.
While it’s still too early to tell whether a significant move for industrials is underway, all three of these railroad stocks are on the right track.
