This week, we use AAII’s A+ Investor Stock Grades to give you insights into three railroad stocks since rail transport companies are in the crosshairs of the media due to recent events involving derailments. In the past few months, rail workers’ rights have been a hot-button debate, with workers threatening strikes due to low wages and lack of sick days. Following the Norfolk Southern train derailment in East Palestine, Ohio, some workers are citing cost-reduction methods used by the companies as the catalyst for increases in derailment events. With massive potential ecological damage, there could be legislation in the works to prevent future incidents.
For investors focused on companies that transport the world’s infrastructure and goods, railroad stocks CSX Corp. (CSX), Norfolk Southern Corp. (NSC) and Union Pacific Corp. (UNP) may be of interest to your portfolio.
Rail Traffic Down in 2022, Cause for Concern?
The transportation sector is generally a reliable bellwether for the economy. For the year ending December 31, 2022, the Association of American Railroads (AAR) reports that total U.S. rail traffic was down 2.8% year over year to 25.4 million carloads and intermodal units. Compared to the prior-year period, carloads are down 0.3% to 11.9 million and intermodal volume is down 4.9% to 13.4 million. Four of the 10 carload commodity groups are up for the year, including coal, farm products (excluding grain and food), motor vehicles and parts, as well as nonmetallic minerals.
In addition, President Biden’s infrastructure plans to spend billions on roads, bridges, airports, railways, sources of renewable energy, power grids and other major infrastructure projects gained bipartisan support. Now that a large infrastructure spending bill has passed, it will likely boost the sales and earnings for a variety of companies in the basic materials and industrials sectors. Additionally, the Biden administration has significantly expanded standards to require that federally funded infrastructure projects use American-made iron, steel, construction materials and manufactured products. That means taxpayer dollars funding the country’s infrastructure projects are invested back in American jobs and American manufacturing.
However, potential environmental restrictions on carbon emissions imposed by the administration, and future administrations, could also increase costs to ground transportation in the U.S. Railroads will play a smaller role in renewable energy projects, as there is no repeat shipping required for renewable energy plants like there is for fossil fuel plants and refineries.
The recent train derailment in East Palestine, Ohio, brought the railroad system regulations and safety procedures into question. A highly flammable and carcinogenic chemical, vinyl chloride, was on board a train that derailed, causing a massive spill that was eventually determined to be dissipated via a “controlled burn.” Union heads noted that they had alerted federal railroad inspectors to crews that were disregarding safety measures. The potential fallout of this accident has yet to be seen or anticipated, but it could impact some of the biggest transportation corporations across North America.
Grading Rail Stocks With AAII’s A+ Stock Grades
When analyzing a company, it is useful to have an objective framework that allows you to compare companies in the same way. This is one reason why AAII created the A+ Stock Grades, which evaluate companies across five factors that have been shown to identify market-beating stocks in the long run: value, growth, momentum, earnings estimate revisions (and surprises) and quality.
Using AAII’s A+ Stock Grades, the following table summarizes the attractiveness of three rail transport stocks — CSX, Norfolk Southern and Union Pacific — based on their fundamentals.
AAII’s A+ Stock Grade Summary for Three Industrial Freight & Logistics Stocks
What the A+ Stock Grades Reveal
CSX Corp. (CSX) provides rail-based freight transportation services, including traditional rail service and transport of intermodal containers and trailers, as well as other transportation services, such as rail-to-truck transfers and bulk commodity operations. It categorizes its products into primary lines of business such as merchandise, intermodal and coal.
Its intermodal business links customers to railroads through trucks and terminals. Its merchandise business consists of shipments in markets, such as agricultural and food products, automotive, minerals, forest products, metals and equipment and fertilizers. It transports domestic coal, coke and iron ore to electricity-generating power plants, steel manufacturers and industrial plants and exports coal to deep-water port facilities. Its principal operating subsidiary, CSX Transportation Inc., provides an important link to the transportation supply chain through its 20,000 route-mile rail.
In February, CSX reached agreements with four separate unions regarding paid sick leave for railroad workers, a major step forward for rail transportation companies.
CSX has a Value Grade of D, based on its score of 40, which is considered expensive. The company’s Value Score ranking is mixed across several traditional valuation metrics, with a percentile rank of 10 for shareholder yield, 85 for the price-to-book-value (P/B) ratio and 56 for the ratio of enterprise value to earnings before interest, taxes, depreciation and amortization (EBITDA). Successful stock investing involves buying low and selling high, so stock valuation is an important consideration for stock selection.
The Value Grade is the percentile rank of the average of the percentile ranks of the valuation metrics mentioned above along with the price-earnings (P/E) ratio, price-to-sales (P/S) ratio and price-to-free-cash-flow (P/FCF) ratio.
CSX has a Momentum Grade of C, based on its Momentum Score of 45. This means it ranks in the average tier of all stocks in terms of its weighted relative strength over the last four quarters. The weighted four-quarter relative strength rank is the relative price change for each of the past four quarters.
Earnings estimate revisions offer an indication of what analysts are thinking about the short-term prospects of a firm. CSX’s Earnings Estimate Revisions Grade is C, which is considered neutral. The grade is based on the statistical significance of its last two quarterly earnings surprises and the percentage change in its consensus estimate for the current fiscal year over the past month and past three months.
CSX has posted slightly positive earnings surprises for its last two fiscal quarters, driven by higher fuel surcharge, pricing gains and an increase in storage and other revenues. Severe winter weather in late December modestly reduced volumes and revenue for the quarter. Over the last month, the consensus earnings estimate for the fiscal year ending 2023 has decreased from $1.90 per share to $1.865 per share; there have been six upward revisions to the fiscal-2023 estimate and 15 downward revisions.
Norfolk Southern Corp. (NSC) is an industrial freight and logistics company. The company is engaged in the rail transportation of raw materials, intermediate products and finished goods. It offers its services in the Southeast, East and Midwest through interchange with rail carriers to and from the rest of the U.S. It also transports overseas freight through various Atlantic and Gulf Coast ports. The company provides logistics services and offers the intermodal network in the eastern half of the U.S. The company’s system reaches various manufacturing plants, electric generating facilities, mines, distribution centers, transload facilities and other businesses located in its service area.
Norfolk Southern has a Growth Grade of B. The Growth Grade considers both the near- and longer-term historical growth in revenue, earnings per share and operating cash flow.
The company has exhibited strong sales growth over the past two years. Sales increased 14.4% year over year for the 12-month period ended December 31, 2022, and 13.8% for the 12-month period ended December 31, 2021. Operating income increased substantially in 2021, up 48.1%, and up 8.1% in 2022. The company has significantly increased profitability with net income increasing 49.4% in 2021 and 8.8% in 2022. The company is under fire from its handling of the East Palestine, Ohio, train derailment, causing many people to question how the company is utilizing the increased profit.
The company has a Momentum Grade of D, based on its Momentum Score of 35. Norfolk Southern has a weighted relative strength value of –4.2%. This translates into a momentum score of 35, which is considered weak. The weighted four-quarter relative strength rank is the relative price change for each of the past four quarters. The most recent quarterly price change is given a weight of 40% and each of the three previous quarters are given a weighting of 20%. From the train derailment on February 3, 2023, to close of February 21, 2023, Norfolk Southern has seen a 10.9% decline in price versus a 3.4% price decline for the S&P 500 index.
Earnings estimate revisions offer an indication of what analysts are thinking about the short-term prospects of a firm. Norfolk Southern’s Earnings Estimate Revisions Grade is C, which is considered neutral. The grade is based on the statistical significance of its last two quarterly earnings surprises and the percentage change in its consensus estimate for the current fiscal year over the past month and past three months.
Over the last month, the consensus earnings estimate for the fiscal year of 2023 has decreased from $13.972 per share to $13.752 per share; there have been three upward revisions to the fiscal-2023 estimate and 23 downward revisions.
Union Pacific Corp. (UNP) is a railroad operating company in the U.S. The company operates through Union Pacific Railroad Co. (UPRR). The company connects approximately 23 states in the western two-thirds of the country by rail and maintains coordinated schedules with other rail carriers for the handling of freight to and from the Atlantic Coast, the Pacific Coast, the Southeast, the Southwest, Canada and Mexico. The company’s railroads diversified business mix includes bulk, industrial and premium.
The company’s bulk shipments consist of grain and grain products, fertilizer, food and refrigerated and coal and renewables. Its industrial shipments consist of several categories, including construction, industrial chemicals, plastics and forest products, among others. Its premium shipments include finished automobiles, automotive parts and merchandise in intermodal containers, both domestic and international.
The A+ Quality Grade is the percentile rank of the average of the percentile ranks of return on assets (ROA), return on invested capital (ROIC), gross profit to assets, buyback yield, change in total liabilities to assets, accruals, Z double prime bankruptcy risk (Z) score and F-Score. The score is variable, meaning it can consider all eight measures or, should any of the eight measures not be valid, the valid remaining measures. To be assigned a Quality Score, though, stocks must have a valid (non-null) measure and corresponding ranking for at least four of the eight quality measures.
Union Pacific has a Quality Grade of A, putting it in the top tier among all U.S.-listed stocks. The company ranks highly in terms of its return on assets and F-Score, ranking respectively in the 88th and 86th percentiles of all U.S.-listed stocks. However, it ranks poorly in terms of its change in total liabilities to assets, in the 35th percentile. The company has a buyback yield of 4.3%, ranking in the 90th percentile.
Union Pacific currently has a Growth Grade of B, ranking in the 64th percentile among all U.S. stocks. The company ranks in the 63rd percentile for five-year annual sales growth at 3.2% but trails the sector median of 6.0% over the same period. Union Pacific has generated positive annual cash from operations for the past five fiscal years. This translates into a rank of 65. Union Pacific has seen its sales increase year over year for three out of the past five fiscal years, ranking in the 47th percentile.
The stocks meeting the criteria of the approach do not represent a “recommended” or “buy” list. It is important to perform due diligence.
If you want an edge throughout this market volatility, become an AAII member.