This Stock Is the Best Railroad to Buy

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The American railroad industry has many great firms with long operating histories.  Norfolk Southern ) is no exception—the company was founded in 1886.  Other railroads, including CSX ) and Union Pacific ) are successful companies as well.  However, at the present time it appears that Norfolk Southern is trading at a measurable discount to its peers.  The railroad industry’s price-to-earnings and price-to-earnings growth (PEG) ratios exceed 15 and 1.3, respectively.  CSX and Union Pacific carry valuation metrics close to these industry averages.  Meanwhile, Norfolk Southern has a P/E ratio of less than 12 and a PEG ratio less than 1.  While Norfolk Southern has encountered some struggles in 2012, the stock’s drop in price has created a compelling opportunity for potential investors.

Financial performance

Norfolk Southern operates approximately 20,000 route miles in 22 states and serves every major container port in the eastern United States.  The company’s full-year 2011 results were impressive.  Revenues increased almost 17.5% versus 2010.  Net income grew more than 28% year over year.  The company increased its divided more than 18 percent during the year, and still carried a very comfortable 30 percent payout ratio.

The first nine months of 2012 proved challenging for the company.  Revenue through the first three fiscal quarters was roughly flat versus the prior year, and net income fell 7 percent during the first nine months year over year.  The company’s struggles were primarily due to a drop in coal volumes.  The company derives roughly a quarter of its revenues from coal.  Coal sales fell almost 15 percent through the first three quarters of 2012.  Much has been made of the decline in coal usage in the United States, due to political pressures and a collapse in natural gas prices.  Assuming some stabilization in coal shipments, the company should return to its normal level of financial performance.  Norfolk Southern is scheduled to present its fourth quarter financial results later this month, and investors would be well-advised to pay attention to the state of its coal shipments.

Stock drop creates opportunity

Investors did not embrace Norfolk’s 2012 results well, pushing the stock price down from $78 per share at the beginning of the year to its current level of $65.  Because of this, Norfolk Southern is trading at its cheapest valuation since the financial crisis of 2008-2009.  The trailing price-to-earnings ratio is less than 12, a level not seen since 2009.  Moreover, the forward P/E ratio is only 11.5.

In addition, the dividend yield is now over 3 percent.  Norfolk Southern’s yield hasn’t eclipsed 3 percent since late 2009.  Furthermore, the company’s dividend continues to grow at a superb rate.   Norfolk Southern raised its dividend twice in 2011, and twice again in 2012.  Over the last five years, the compound annual growth rate of the company’s dividend is nearly 14 percent.  The dividend has almost doubled over the last five years, and due to the company’s solid free cash flow generation and low payout ratio, should continue to grow solidly for the foreseeable future.  At current prices, Norfolk Southern would be a great addition to nearly every investor’s portfolio.

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