Is Union Pacific the Best Railroad Stock?

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Railroads are an industry looked favorably upon by many investors, including Warren Buffett. He’s perhaps the most famous investor in the world, and he acted on his fondness for railroads by purchasing Burlington Northern Santa Fe, in a $34 billion deal in 2009.

There’s good reason to love railroads. They’re seen as major economic bellwethers for the variety of industrial goods they transport. In essence, as the railroads go, so goes the nation.

One of the most well-known of the publicly traded railroad operators is Union Pacific (NYSE: UNP), which has richly rewarded its investors for many years. Is UNP the best railroad to buy today? Or is there an industry competitor more deserving of your investing dollars?

An industry outperformer in a difficult 2012

Last year was a very difficult one for the railroad industry. The economic and political uncertainties presented by the frustratingly slow recovery in the U.S. and the election served as an anchor on economic activity.

However, Union Pacific managed to perform admirably last year. While most railroads saw stagnating volumes and profits, Union Pacific outperformed its U.S. rivals. 2012 was actually the most profitable year in Union Pacific’s 150-year history. The company reported 23% growth in diluted earnings per share, with EPS coming in at $8.27 per share.

In addition, the good times kept up in the first quarter of 2013. Union Pacific racked up another profit record, seeing another 13% growth in diluted EPS.

Making things even better, Union Pacific isn’t shy about sharing its success with its owners. The company has paid uninterrupted dividends on its common stock for 113 years in a row. And, Union Pacific has actually raised its dividend on an annual basis for many years. Last year, the company gave its shareholders a 15% pay raise to its current distribution of $2.76 per share annualized.

An overview of industry competitors

Of course, there are many publicly-traded railroad stocks to choose from. Industry peers include CSX (NYSE: CSX) and international competitor Canadian Pacific Railway (NYSE: CP).

CSX is a smaller railroad than Union Pacific, holding a market value about $50 billion less than UNP. At the same time, however, CSX has a large operational footprint. The company serves major markets in the eastern United States and has access to over 70 ocean, river and lake port terminals along the Atlantic and Gulf Coasts, the Mississippi River, the Great Lakes and the St. Lawrence Seaway. In total, CSX operates a rail network of approximately 21,000 miles.

CSX struggled during fiscal 2012, as the company was only able to eke out a tiny increase in revenue versus the prior year. In addition, the company reported just 7% diluted earnings per share growth for 2012 year-over-year.

CSX kept its head above water last year and fortunately improved measurably during the first quarter. Over the first three months, revenue remained flat, but CSX posted record operating income and earnings per share. In addition, CSX provided investors with a 7% dividend increase.

Canadian Pacific Railway, as its name suggests, is headquartered in Calgary and operates mainly throughout Canada, although the company does have operations in the U.S. as well.

Canadian Pacific trades more or less in line with its competitors, holding a forward P/E multiple of 15 times, whereas Union Pacific and CSX trade for 15 times and 12 times forward earnings. Although, judging by Canadian Pacific’s fantastic first quarter, it may very well deserve a higher multiple.

Canadian Pacific’s first quarter of 2013 was the best quarter in its 132-year history. The company’s earnings skyrocketed 53%, and CEO Hunter Harrison added that he expects great results for the remainder of the full year.

Few degrees of separation

These three railroads operate extremely similar businesses, and consequently, their stocks trade similarly. However, while CSX’s results in recent quarters have been hampered by the struggles seen in coal shipments, Union Pacific and Canadian Pacific outperform.

That being said, there’s always a price to pay for outperformance. It’s worth noting that UNP and Canadian Pacific hold higher multiples than CSX, and pay lower dividend yields due to their high-flying share prices. CSX currently yields 2.6%, while both Union Pacific and Canadian Pacific yield less than 2% at recent prices.

At the same time, it appears that in the railroad industry, you get what you pay for. Union Pacific and Canadian Pacific certainly aren’t expensive at current levels and have businesses that are on more solid financial footing than most industry competitors. As a result, I’d consider Union Pacific and Canadian Pacific to be best-in-breed railroads in the current environment.

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