3 Railroads That Could Continue To Outperform

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

As natural gas continues to replace coal, many North American railroads have begun struggling to retain their growth momentum. Even the upcoming coal gasification plants in the continent won’t be operational until 2018, which suggests that the domestic coal demand could continue to decline. However, intermodal transportation is picking up rapidly, and North American railroads with mature intermodal routes are coming out unscathed.

Company #1

Norfolk Southern (NYSE: NSC) currently operates 22,00 route miles in 22 states, and has the most extensive intermodal transportation network in the eastern states. But the company isn’t stopping here.

To expand its intermodal transportation, Norfolk Southern announced the launch of its new intermodal terminal at Dakota earlier this year. The company also launched its Thoroughbred Bulk Transfer terminal in Knoxville last month. Apart from these new terminals, the company is also adding new service lanes, which should altogether boost its intermodal transportation.

As of now, its coal and intermodal revenues account for 23.5% and 21.2% of its overall revenue, respectively. Its balanced revenue mix allows Norfolk Southern to enjoy the best of both worlds. In the recent quarter, its revenues from coal shipments plunged by 17%, but a 9% spike in its intermodal revenues allowed the company to beat the Street’s estimates.

As a result of its solid revenue growth, shares of Norfolk Southern have risen by 25% over the last year. And analysts at BMO Capital Markets estimate its fair price to be around $91 per share (around 18% premium).

Company #2

Canadian Pacific (NYSE: CP) wasn’t always the charming one. The company witnessed its rapid growth after William Ackman started to shake things up. It began taking advantage of the declining road transportation and rising rail shipments by strategically expanding its railroads network.

Canadian Pacific also expanded its Vancouver facility last year, which is why its grain volumes rose by 13% during Q1FY13 (YoY) with 10% fewer cars. Also during the quarter, its coal volumes were up by 12%.

Its coal segment still generates most of its revenue, which saw a 9% spike in its quarterly report due to strong international demand for met coal. But its quarterly revenues from intermodal transportation declined by 4%. I don’t think that’s a cause of concern, because intermodal transportation currently generates around 25% of its total revenues, which is 200bps – 300bps higher than most of its peers.

Besides that, Canadian Pacific posted a record quarter with a net income of $213.6 million. As a result of this continued impressive performance, shares of Canadian Pacific have more than doubled over the last three years, and have outperformed the entire railroad industry. And analysts estimate that its annual EPS could still grow by 23.3% for the next 5 years.

Company #3

Even Canadian National Railway (NYSE: CNI) has been reporting stellar financial growth. Over a 5 year period its net income has risen by over 20%, while its shares more than doubled in value. The company continues to benefit from its significantly higher gross margins of 49%, as compared to the industry average of 27% (which have fattened by 21.7% over the past 5 years).

The company will be launching a terminal for intermodal transportation at its Joliet yard in Illinois this month. The terminal would be spread across 30 acres of land, which can accommodate up to 175 trucks and eventually allow better connectivity to the Asian markets.

Its worth mentioning that Canadian National is the largest railroads company in Canada. During FY12, the company generated $9.85 billion in total revenue, while its intermodal segment contributed around $1.99 billion. Its business divisions are extensive and mature, which is why its hard for Canadian National to report radical growth like Norfolk Southern.

However, its geographic diversification also results in better efficiency (higher margins) and adds stability to its top line. According to analyst consensus, Canadian National’s annual EPS could grow by 12.9% for the next 5 years. Additionally, analysts at BMO Capital estimate that its shares could appreciate by around 10%.

Final words

All three companies are very different from each other and offer myriad growth prospects. In order take advantage of the recovering industrial sectors (domestic and abroad), creating a portfolio all the mentioned companies would be a great way to spread the risks and rewards.

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Piyush Arora has no position in any stocks mentioned. The Motley Fool recommends Canadian National Railway. 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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