Railroad Stocks Look Set To Perform Well In 2018: Here's Why

Stocks in the railroad industry performed well in 2017 after struggling to find stability for the past couple of years. Factors including increased coal and intermodal revenues have led to this improved scenario.

Impressive Q4

Most sector participants dished out an impressive performance in the fourth quarter of 2017 on the back of strong volume growth. In fact, key players namely Union Pacific Corp. (NYSE:UNP) , Norfolk Southern Corp. (NYSE:NSC) and Kansas City Southern (NYSE:KSU) have reported substantial year-over-year improvement in earnings as well as revenues.

Norfolk Southern has reported better-than-expected earnings per share and revenues in the fourth quarter of 2017. This Zacks Rank #2 (Buy) company’s bottom line rose 19% on a year-over-year basis while the top line improved 7% year over year.

At Union Pacific, earnings per share and revenues increased 10.1% and 5.5%, respectively, year over year. Whereas at Kansas City Southern, both metrics grew 23.2% and 10.3%, respectively. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Price Performance

The buoyant performance of railroad stocks in 2017 is well-reflected by its price performance. It surged 30.4%, significantly outperforming the S&P 500 Index’s 19.6% rally.

We expect the sector to continue performing well in the current year. The factors contributing to this positive scenario are as follows:

Coal and Intermodal Revenues

Coal is considered a key revenue-generating commodity for railroads. With Trump’s presidency, the coal industry is seeing better days. In a bid to revive the industry, the president intends to relax regulations that were hurting its prospects.

Rising natural gas prices are also favorable to boosting demand for coal. Moreover, per the U.S. Energy Information Administration, coal production in the country is likely to increase by 2018. Since revenues from coal significantly drive the railroads’ top line, any positive development for the commodity augurs well for the sector.

Coal aside, the intermodal space is a key revenue source for railroads, which improved by leaps and bounds in 2017. Per the Intermodal Association of North America, intermodal volumes registered the highest growth rate during the third quarter of 2017. In fact, intermodal shipments are expected to expand 4.2% in 2018, strengthening the top line for railroads in turn.

Improved U.S. Economy

Recovery of U.S. economy is also anticipated to pave way for the railroads’ progress. Notably, U.S. GDP is expected to climb 2.4% in 2018, higher than the level achieved in the past couple of years. Generally, a buoyant domestic economy results in an uptick in rail shipments of goods across the United States.

Per the Commerce Department’s latest report, the inland economy appreciated at a 3% decent annual rate implying a better economic scenario. Moreover, this reading was above the consensus estimate of 2.6%.

The New Tax Law

Trump’s proposed policy changes have made the overall economic outlook fairly bullish. The two pro-growth presidential agendas such as a vital corporate tax cut and deregulation are major catalysts to the U.S. economy.

Given the capital-intensive nature of railroads, this policy seems a huge vantage point for the sector. Under the current legislation, corporate taxes have been reduced to 21% from the previous 35%. Also by dint of the revised law, companies will be able to immediately subtract capital expenditures from the taxable income in the year of their occurrence.

As a result, their annual tax bills would be lowered significantly due to higher deductions. This in fact leaves more cash in hand for these companies to fund capital expenditures, acquisitions and share repurchases among others.

Moreover, the amended tax law has prompted several companies to hike their quarterly dividend payouts. Companies like Canadian National Railway Co. (NYSE:CNI) , CSX Corp. (NASDAQ:CSX) and Union Pacific Corp. have raised dividends earlier this year, indicating financial prosperity. Further, we expect this new law to enhance these shareholder-friendly activities.

Zacks Industry Rank Highlights the Bright Picture

The Zacks Industry Rank of 64 (of 250 plus groups) carried by the Zacks Rail Industry also emphasizes the optimistic sentiment revolving around railroad stocks. This favorable rank places the companies within the top 25% slot of the Zacks industries.

We classify our entire 250-plus industries into two groups: the top half (i.e. industries with the best average Zacks Rank) and the bottom half (industries with the worst average Zacks Rank).

Using a week’s rebalance, the top half beat the bottom half by a factor of more than 2 to 1 over the last decade.

Click here to know more: About Zacks Industry Rank

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