Sometimes the best portfolio opportunities can be the most boring. And few industries are as un-sexy as railroads. Shuttling freight – from cars and coals, to toasters, oil and lumber – across the country just doesn't capture the imagination like an iPhone or the latest blockbuster movie.
That said, there have been more than few reasons lately for savvy investors to turn their attention to the rails.
Left for dead nearly a decade ago, railroads stocks have been surging driven by new growth opportunities and fracking. For investors, these wide-moated firms could be some of the best places to put your money for the longer term. (For related reading, see: A Primer On The Railroad Sector).
Rising Freight Volumes
With the U.S. economy building steam, freight traffic has followed suit. According to the Association of American Railroads (AAR), U.S. freight car-load traffic rose 5.3% for the week ending June 7 versus the same week last year. That growing volume builds on the already impressive gains the railroad sector has had since the end of the recession in 2010. So far, during the first 23 weeks of this year, freight volumes for U.S., Canadian and Mexican railroads have gained 2.1%, while combined North American intermodal freight saw volume rise 5.7%.
Those rising freight volumes have already ignited a fire railroad under stocks. The iShares Transportation Average ETF (IYT), which features a hefty slug of railroad companies, continues to hit new highs. Yet, more could be ahead for the sector.
First, there’s America's NAFTA trading partner Mexico to consider. Recent reforms and measures to spur economic development in the nation have helped reinvigorate its low-cost manufacturing status. Many American manufacturers have begun the process of moving facilities back, as rising Chinese labor and transportation costs have now made Mexico a cheaper option. Mexico is now the 8th-largest auto manufacturer in the world. That’s resulted in parts and components being shipped south of the border and finished goods being shipped back – mostly via rail.
Then there’s America's energy revolution to consider.
The growth in hydraulic fracturing of shale fields like the Bakken have unleashed an ocean of energy. However, the lack of pipeline infrastructure has made getting that oil to refineries quite difficult. As a result, energy firms are using the railroads to ship their product and crude-by-rail volumes have exploded. In Canada alone, shipments of crude-by-rail have jumped 900% since 2012. (For more on this topics, see: Railroads Gear Up To Serve The Bakken)
Rising freight volumes along with growth catalysts in energy have made the sector a perfect buy for longer term investors. While IYT and SPDR S&P Transportation ETF (XTN) have exposure to railroads, the best way to play the sector is through individual picks.
One of the best could be Union Pacific Corp. (UNP).
UNP is at the forefront of both of the major catalysts propelling the railroad sector. The company’s 32,000 miles worth of rail lines run directly through the upper Midwest – the heart of the United States energy boom. Crude-by-rail volumes at the railroad have surged and have powered profits. At the same time, Union Pacific is the firm in the sector with exposure to all six gateways into Mexico.
However, rivals are closing in on UNP’s territory. A recent expansion at Kansas City Southern (KSU) has helped it become the only railroad with lines connecting Mexico City and the port city of Veracruz with Texas shipping hubs.
For strictly crude-by-rail players, both Canadian Pacific Railway Ltd. (CP) and Canadian National Railway Co. (CNI) have both capitalized on Bakken shale and Alberta oils sands activity. Both CP and CNI reported better-than-expected earnings last year – driven primarily by strong crude-by-rail volumes.
Finally, all of this rising rail traffic has benefited the manufacturers of box and tank cars, as well as other railroad equipment producers. Both American Railcar Industries (ARII) and Trinity Industries Inc. (TRN) have profited immensely from rising tank car orders. The same can be said for brake specialist and locomotive gear maker Westinghouse Air Brake Technologies Corp. (WAB), which has seen orders tick up in recent quarters. TRN recently received a huge price target upgrade, while analysts expect WAB’s profits to grow 14% this year and 15% next. (For related reading, see: Railroad Industry Stock Outlook)
The Bottom Line
While it’s historically a boring industry, there’ nothing boring about the railroads today. There’s plenty of growth to drive shares up. More importantly, those catalysts will continue over the longer term, possibly making them a solid buy for investors.