Operating Efficiency Puts Railroad Stocks Back on Track

Efficiency initiatives have improved operational performance

Slowing industrial activity caused by the protracted U.S.-China trade dispute has ravaged railroad companies' freight volumes in 2019. While stocks in the segment mostly shrugged off falling carload figures in the first half of the year to provide comparable returns to the broader market, over the past three months, the group has fallen 2.08% compared to the S&P 500's gain of nearly 1%.

Washington and Beijing made some progress on the trade front earlier this month, but economic growth looks likely to remain sluggish for the rest of the year before recovering slightly in 2020. The International Monetary Fund (IMF) report for October forecasts world gross domestic product (GDP) growth of 3.4% next year – up from 3% in 2019. Amid the slowly improving macro backdrop, railroad operators should also continue to benefit from operational efficiencies they've rolled out over the past few years. From reducing headcounts to implementing cost-cutting initiates, each of the major train companies has worked tirelessly to optimize performance.

From a chart perspective, breakouts above key technical levels among leading railroad stocks indicate further upside momentum in coming trading sessions. Below, we take a more detailed look at the operational performance of Union Pacific Corporation (UNP), CSX Corporation (CSX), and Norfolk Southern Corporation (NSC), as well as go over possible trading tactics. 

Union Pacific Corporation (UNP)

Union Pacific engages in railroad operations in North America – transporting coal, industrial products, intermodal containers, agriculture goods, chemicals, and automotive goods. Last week, the 157-year-old freight carrier posted third quarter (Q3) adjusted earnings per share (EPS) of $2.22 on revenues of $5.5 billion. The firm's bottom line grew 3.3% from the year-ago quarter due to lower costs. Its operating expenses declined 10% to $3.28 billion, with the company's operating ratio improving to 59.5% from 61.7% a year ago. Union Pacific's prudent operational efficiency along with price increases helped to offset an 8% slide in carload volumes. The railroad operator's stock has a market capitalization of $114.44 billion, offers a 2.40% dividend yield, and is up nearly 23% year to date as of Oct. 22, 2019.

Although the 50-day simple moving average (SMA) recently crossed below the 200-day SMA to generate a "death cross" sell signal, Union Pacific shares closed above the top trendline of a descending channel yesterday that may result in a test of the 52-week high at $179.43. Those who anticipate a move to this level and enter here should place a stop-loss order below $160. The trade offers a favorable risk/reward ratio of about 1:2.75 ($7.08 risk per share vs. $19.43 profit per share), assuming an execution at Monday's $167.07 closing price.

Chart depicting the share price of Union Pacific Corporation (UNP)

CSX Corporation (CSX)

With a market value of $54.47 billion, CSX provides rail-based freight transportation services in the eastern United States. The Jacksonville, Florida-based operator hauls coal products, chemicals, intermodal containers, and automotive cargo. CSX also released its 3Q results last week, posting EPS of $1.08 to deliver a 7% earnings surprise. Efficiency improvements, reduced headcount and lower fuel costs contributed to the company's better-than-expected bottom-line performance. Its operating ratio improved to 56.8% from 58.7% in the prior-September quarter. Meanwhile, revenue for the period decreased 4.8% amid weakness in the railroad's coal and intermodal segments. As of Oct. 22, 2019, CSX stock issues a 1.40% dividend yield and has returned 15.03% on the year.

The railroad company's shares have tracked within a loosely constructed descending channel since April. Price closed above the pattern's top trendline on Thursday, Oct. 17, after the firm released its upbeat earnings but gave back all those gains the next day to warn of a possible head-fake breakout. However, the bulls reasserted themselves in Monday's session, with the stock jumping over 3% to close above the channel's upper resistance at $68. Those who hop aboard a long position should set a profit target near the late spring or early summer highs around $80 and protect trading capital with a stop placed just beneath intermediate support at $68.

Chart depicting the share price of CSX Corporation (CSX)

Norfolk Southern Corporation (NSC)

Norfolk Southern provides rail transportation of raw materials, intermediate products, and finished goods such as automobile, agriculture, metal, chemical, and forest products. Analysts expect the $48.56 railroad company's 3Q EPS to come in at $2.57, a nickel higher than the same quarter last year, when it reports ahead of the opening bell on Wednesday, Oct. 23. Like the two rail operators discussed above, weak freight volumes likely pressured Norfolk's top line during the period. In Q2, the company's expense ratio improved to 63.6% from 64.6%, and it is expected to have improved again in the September quarter from further cost-cutting measures that are part of an expense reduction plan to drive annual savings of more than $650 million by 2020. Trading at $186.19 and paying a 2.07% dividend yield, Norfolk Southern stock has gained 26.29% YTD, outperforming the railroad industry average by almost 5% as of Oct. 22, 2019.

Norfolk shares added most of their YTD gain between January and April but have since traded mostly sideways to lower. A "W" pattern bottom has formed over the past three months, indicating a possible reversal back to the upside. Furthermore, as the pattern's most recent bottom carved a lower low, the relative strength index (RSI) forged a shallower low – referred to as a bullish divergence that indicates slowing seller momentum. The buy signal came Monday when the stock closed above both the pattern's neckline and 200-day SMA. Traders who enter should look for a move up to crucial overhead resistance at the $205 level and place stops somewhere below $180.

Chart depicting the share price of Norfolk Southern Corporation (NSC)
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