A barometer for economic activity, the transportation sector serves a vital purpose to the economy. While shipping volumes have significantly increased on a year-over-year basis, when compared to 2007 and 2008 levels, there is still significant ground to make up. For example, in the latest American Railroad Association Railroad Traffic Report, American carload volume increased by 4.1% while increasing in Canada by 19%. However, when compared to 2008 levels, carload transportation was 5.1% and 7.5% below historic levels. Additionally, on a sequential basis, shipments have decreased, adding another negative economic indicator to the list of recent announcements.
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Although transportation stocks have lost some value in recent trading, it is a solid long term investment. According to Citigroup (NYSE:C) analyst Math Troy "The reason Warren Buffett [bought] Burlington Northern Santa Fe is a 10- to 20-year trend. For us near-term investors, it may seem curious. For him, the trajectory of the recovery over the next one or two years is irrelevant." With strong revenue and earnings momentum, in addition to providing a more efficient service than alternative transportation means, the railroads are capturing a greater market share of the transportation space. (Forget the latest craze - you're more likely to succeed with a buy-and-hold strategy. For additional reading, see Long-Term Investing: Hot Or Not?)
Kansas City Southern (NYSE:KSU) is up 45% in the last year, outperforming the iShares Dow Jones Transport Average (NYSE:IYT), an ETF that has exposure to 21 diverse companies in the transportation industry, by nearly 35%. With significant sequential growth in both U.S and Mexican operations, KSU operates with gross and net profit margins that are superior to other players in the industry.
Union Pacific Corporation (NYSE:UNP) and Norfolk Southern Corporation (NYSE:NSC) are also among the top performers within this industry, outperforming the IYT ETF by a wide margin. Analysts expect UNP to perform well moving forward, with a mean target price of $90.13 according to a 23 person poll conducted by Thomson/First Call. Stifel Nicolaus recently upgraded the stock from "hold" to "buy" and FBR Capital initiated coverage with an outperform rating. Norfolk Southern also has strong approval from the investment community with a mean target price of $68.14.
Similar to other major railroads, KSU has significant compensation and fuel costs that make up 28% and 21%, respectively, of total expenses. Likewise, Canadian Pacific Railway (NYSE:CP) faces $354 million and $182 million in compensation and fuel expenses which amount to 37% and 19% of total expenses. These two factors pose some of the greatest risks to the industry. While swaps and other option contracts are used to hedge crude oil and diesel prices, unionized workers demand high wages, which put a strain on railroad profit margins.
Freight volumes indirectly indicate the level of operational activities of railroad customers; when companies in the food and beverage space, for example, are experiencing increased product demand, they will ship more goods to their facilities. Last month, of the 18 industries tracked by AAR, only 10 showed growth, the lowest number in 2010. As a result, Kansas City Southern, Union Pacific Corporation, Norfolk Southern and Canadian Pacific have all dropped in price within the past month as external industry activity fell below expectations. As a matter of fact, every major American and Canadian railroad corporation experienced a pullback in stock prices within the last month. Luckily, railroads are a long-term investment.
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