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Railroad Stocks Like CSX Are Hauling Big Profits

A reader recently wrote in to ask what I think about CSX Corp. (NYSE:CSX), one of the largest American railroad stocks.

The short of it: I think this entire sector is a buy, which includes CSX as well as its peers.

CSX is one of the biggest railroads in the United States alongside Union Pacific (NYSE:UNP). CSX dominates the eastern U.S., while Union Pacific covers the most of the West. A third major player, Norfolk Southern (NYSE:NSC), serves mainly the Gulf Coast and Southeast, along with the Midwest and select ports on the Atlantic Coast.

Among the three of them, they have the entire U.S. covered. And as the economy slowly gains momentum, they will see greater business and goods move about America’s rails to manufacturers, merchants and other destinations.

Here’s what railroad stocks generally and CSX specifically have going for them:

Cyclical Strength in Short Term

A big story lately has been cyclical stocks outperforming on optimism about the recovery. Year-to-date, the iShares Dow Jones Transportation Average ETF (NYSE:IYT) — an indexed fund tied to the Dow Transports — is up more than 15% vs. 12% for the S&P 500. Railroads are seeing the bounce even more, with CSX, UNP and NSC stock all up 18% or better since Jan. 2.

Other transports of note include:

  • Barge operator Kirby (NYSE:KEX), up 24% YTD.
  • Trucker J.B. Hunt (NASDAQ:JBHT), up 19% YTD.
  • Airline Delta Air Lines (NYSE:DAL), up 40% YTD.

So railroads are just one great way to tap into this trend.

Stability and Dividends in the Long-Term

Thanks to the highly regulated nature of railroads and the capital intensive business of operating trains and laying track, CSX is entrenched and not going anywhere. Although there are indeed a handful of railroads, they don’t really compete — much in the way that Comcast (NASDAQ:CMCSA), Time Warner Cable (NYSE:TWC) and a few other major cable players largely leave each other alone.

Except while technology is disrupting television, there’s no other option on the horizon for transporting 10 tons of coal from West Virginia to a port for export.

This strong baseline demand and lack of competition has allowed for a firm floor under railroad stocks, and the reliable revenue for decent dividends. CSX currently yields 2.5%, while Norfolk Southern is 2.7%. Union Pacific lags with a yield of roughly 1.9%.

CSX stands out because, adjusted for splits, its dividends have increased from about 1.7 cents a quarter in 2005 to 14 cents — an increase of more than sevenfold in less than a decade! Also, dividends have been paid in some form since 1922.

The Risks

Of course, there are no sure things on Wall Street. So here are the risks as I see them for railroad stocks like CSX:

Cyclicals Wax and Wane: What happens if all this optimism over the recovery loses steam and economic indicators stall, as they have been wont to do? The sluggish recovery and persistently high unemployment rate naturally mean we see fits and starts — for transports, for materials stocks, for retail stocks and for other cyclical businesses. If the recovery hopes roll back, so will railroad stocks.

Export Weakness: In addition to domestic goods and intermodal travel from port to distribution centers, railroads are heavily dependent on exports — particularly of energy like crude and coal or grains like soy and corn. There is continued concern about weakness in China, and that could result in less demand for these major U.S. exports to Asia.

Top-Line Struggles: While profits are decent at rail stocks, revenue remains pretty flat and there’s not a lot of growth to be had in the near-term. Looking at CSX again, its recent earnings report showed profits beat in Q1 with a record amount of operating income, but revenues hardly budged. That’s a concern, since efficiency can only get you so far.

Still, with these risks in mind, the valuations seem fair. CSX and Norfolk Southern have forward P/E ratios of about 11.9; Union Pacific is a bit higher at 13.8.

Thanks to a higher dividend yield and lower earnings multiple, I tend to favor CSX and NSC over Union Pacific. I think a long-term investor would be well-served in either of these plays.

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Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at editor@investorplace.com or follow him on Twitter via @JeffReevesIP. As of this writing, he did not own a position in any of the stocks named here.

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