In a world dominated by technology, Google (GOOG) this and Facebook (FB) that, let's take a few minutes to go old-school with the railroads. After the tough market we've had over the last decade few stocks have outperformed Union Pacific (UNP) or CSX (CSX) shares, 286%, and +250%, respectively. The railroads may seem old-fashioned and yet they have never been more high tech, more energy efficient, more profitable, or busier. Railroads provide the investor a great play on the coming U.S> economic recovery, with growing dividends and double digit earnings growth.
Somehow despite the sector being red hot over the last decade Wall Street has yet to provide an exclusively railroad weighted ETF for investors. I will call mine (CHOO), a call out to the old coal fired trains of decades ago. "CHOO" will be relatively concentrated but focus on three key characteristics of the sector: Core, growth, contrarian.
"CHOO" Rail ETF
Union Pacific Corporation: Core Holding, 45% weighting
53.5B market cap, 2.12% yield
Overview:
Union Pacific is the core holding of the "CHOO" ETF at 45%. UNP is a behemoth in the U.S. railroad industry, setting the standard in operating excellence and operating scale. UNP serves 23 states in the western 65% of the country, exposing the company positively to the growing west, and California, the world's sixth largest economy. Operating out west, Union Pacific is substantially shielded from decreasing coal shipments in the sector, and looks to benefit from strong growth in manufacturing and farm output in the Midwest. UNP is best in class, a great place to be.
Earnings Outlook:
Union Pacific reported strong Q1 earnings and guidance looked solid. UNP is currently trading at 15.1x earnings, and looks to earn $8.12 per share for 2012, and $9.28 per share for 2013. Earnings the next two years will grow roughly 20% leaving the shares trading at 12x 2013 earnings. Also of note UNP raised its dividend from 48 cents to 60 cents, a 20% increase, in 2011.
Canadian National Railway: (CNI), Core Holding, 20% weighting
35.B market cap, 1.8% yield
Overview:
Canadian National Railway is a smaller core holding of the "CHOO" ETF with a 20% weighting. CNI is a high quality, profitable play on global growth and U.S. recovery. For decades to come Canada will be a major supplier of natural resources to the U.S. and abroad. The company is highly profitable with a 33% net profit margin, and looks to play a large part in fueling growth which requires the bountiful resources Canada has to offer. The stock has been chugging higher for years, and with a market cap of only 35B has tons of room to grow.
Earnings Outlook:
Canadian National reported a decent first quarter, and growth is on track. CNI is currently trading at 14.5x earnings, and looks to earn $5.52 per share for 2012, and $6.15 per share for 2013. Earnings the next few year look to grow in the high teens leaving the shares trading at 13.3x 2013 earning.
Kansas City Southern: (KSU), Growth, 20% weighting
7.7B market cap, 1.04% yield
Overview:
Kansas City Southern is the growth holding of the "CHOO" ETF with a 20% weighting. KSU is the smallest of the four "CHOO" holdings but has the greatest profit growth profile. A high quality, small, middle America company, KSU has a strong expansion profile and should double if not triple from its current 7.7B market cap in the coming decade. Middle America is experiencing a renaissance of sorts from farming, livestock and the booming oil and gas operations. KSU is well positioned to chug higher in the long-term.
Earnings Outlook:
Kansas City Southern reported a strong Q1, and the expansion story is intact. KSU is pricier than the other components of "CHOO" currently trading at 21x earnings, but looks to earn $3.51 per share for 2012 and $4.22 per share for 2012. Earnings look to grow 17.5% for 2012 and 22% for 2013. KSU is a growth story and is priced as one. The stock has been a huge winner over the last year, at 30%. Kansas City is a great addition to "CHOO" at current levels and even better on dips.
CSX Corporation: Contrarian, 15% weighting
22.3B market cap, 2.6% yield
Overview:
CSX has been unloved by investors as of late, making it the contrarian trade of the group. Despite strong growth and earnings CSX has lagged its peers as worries over coal shipments dog this high quality growing railroad. What investors are missing is as coal shipments decline, inter-modal shipping of manufactured goods and especially cars along the East Coast has been a blistering and profitable trade over the last few years and forward. Also a long-term bull case for CSX is the fact that the Panama Canal will be widened, leading to increased shipments and profits 5-7 years from now. CSX is the smallest position in the CHOO ETF at 15%, and yet quarter after quarter earnings and management beat expectations.
Earnings Outlook:
CSX reported a decent Q1, highlighting strength in car shipments from BMW, Toyota and GM. CSX is the cheapest railroad in the ETF at 12.4x earnings, and has the highest dividend rate at 2.6%. CSX looks to earn $1.82 per share for 2012 and $2.07 per share in 2013. The earnings growth estimates for CSX have come down from 15% to just above 8% currently, leaving shares to trade at 10.3x 2013 earnings. Decreasing coal shipments short term have really hurt the shares, but long-term natural gas will not remain in the low $2 range, and economic growth in the U.S. will accelerate utilizing CSX's East Coast rail network and growing earnings until investors recognize the diamond in the rough CSX is. Coal can be dirty, but the profits can be golden.
Conclusion:
Railroads move an unbelievable amount of goods thousands of miles efficiently everyday. Everything from cars to furniture, crops, coal, iron ore and livestock. As the U.S. economy recovers, finished goods need to be shipped, and animals need to be fed, railroads will take things where they need to go. They may seem old school, and yet sometimes stability and profitability are rewarded most of all. The railroads have double digit growth ahead and relatively modest market caps. The "CHOO" rail ETF is made up of some of the best companies money can buy, beating the overall market handily, and chugging higher.
Holdings:
Union Pacific Corporation: , Core Holding, 45% weighting
53.5B market cap, 2.12% yield
Canadian National Railway: , Core Holding, 20% weighting
35.B market cap, 1.8% yield
Kansas City Southern: , Growth, 20% weighting
7.7B market cap, 1.04% yield
CSX Corporation: , Contrarian, 15%
22.3B market cap, 2.6% yield
5 year return:
UNP: +93.1%
CNI: +58.6%
KSU: +83%
CSX: +43.5%
S&P500: -11.3%
Buy on dips.
Always do your homework.
Disclosure: I am long UNP.
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