5 Reasons There Is Only One Choice In This Industry

Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

In some industries, there isn't one clear leader. For example, in the retail space you could argue that while Amazon.com appears the clear online leader, Wal-Mart is still the king when it comes to overall sales. However, if investors are looking for the best stock in the railroad industry, there is one leader and then everyone else. I've identified at least five different reasons that Union Pacific (NYSE: UNP) should be an investors first choice in this industry.

They Make More Money:
There are three key numbers I look at whenever I pull apart an earnings report. I look for good revenue growth, good EPS growth, and good operating cash flow growth. Most of the time I have to be pleased if a company can increase two of the three categories, but Union Pacific scores a perfect three for three. The company's major competition comes from CSX (NYSE: CSX) and Norfolk Southern (NYSE: NSC) and to be blunt, they just can't keep up. 

When it comes to revenue growth, Union Pacific increased this measure by 3% in the last quarter. This might not seem too impressive, until you consider that CSX saw revenue decrease 2%, and Norfolk Southern saw a decline of 4%. This top line growth also lead to better EPS performance, with Union Pacific showing a 10% increase. Their competition saw EPS come in flat at CSX, and down 8.45% at Norfolk Southern.

Since EPS can be manipulated, I always check operating cash flow growth. As you might have guessed, Union Pacific outperformed its rivals again. The company was actually the only one of the three to show operating cash flow increase. Union Pacific saw an increase of 4.9% versus declines of 15.61% at CSX, and 5.02% at Norfolk Southern.

Better Performance = Better Dividend Coverage And A Better Balance Sheet
It would be one thing if Union Pacific were generating better earnings and EPS growth by making short-term bets that harmed their balance sheet, or put their cash flow at risk. However, the company is doing the exact opposite. Union Pacific actually shows the best dividend coverage of the three and has the strongest relative balance sheet. 

For long-term investors, a reasonable free cash flow payout ratio is essential. The bottom line is, a dividend is really only as attractive as the cash flow that covers the payout. On this score, Union Pacific's recent payout ratio should make investors very happy. In the last quarter, the company's free cash flow payout ratio was just 44%. Compared to the over 90% payout ratio at CSX, and the over 75% payout ratio at Norfolk Southern, you can see that Union Pacific shareholders have little to worry about.

Union Pacific's superior results also have led to a relatively stronger balance sheet than their competition. Using the debt-to-equity ratio, Union Pacific shows a ratio of 0.44. As you may have guessed, CSX's balance sheet is weaker with a ratio of 1.01, and Norfolk Southern is weaker as well at 0.86.

There Is One Big Reason For This Superior Performance
Like it or not, the coal industry has been under pressure for some time now. When you consider that all three major railroads saw coal volumes drop in the current quarter, it's fairly obvious the industry is struggling. Sometimes outperforming your competition means limiting your exposure to a troubled industry. Union Pacific shows they have an advantage here again as coal represents 20.08% of their overall volume. In addition, the company saw coal volumes drop by 7%, which was better than their competitors. CSX by comparison has the highest exposure to coal at 25.90% of total volumes, with Norfolk Southern close behind at 24.48%. Since CSX saw volume drop by 18%, and Norfolk saw volume decline by 23%, it's no surprise that these companies have trouble competing with Union Pacific. 

Still The Best
This is truly a one horse race. Union Pacific leads their competition in revenue and EPS growth, operating cash flow growth, payout ratio, balance sheet, and coal performance. In addition, the company has the highest expected EPS growth over the next few years. In fact, with the stock trading for a forward multiple nearly equal to its 14.43% expected growth rate, I would argue this is the best stock in the industry bar none. The company doesn't pay quite the yield of CSX or Union Pacific, but their low payout ratio has the potential to change that over time. In some industries, you might pick between two or three leaders, in the railroad industry, there is only one Union Pacific.


MHenage has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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