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Are Railroads Trading at Fair Valuations?

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Railroads trade at a slight discount to the market

The railroad operator industry, as represented by Union Pacific (UNP), CSX (CSX), Canadian National Railway (CNI), Norfolk Southern (NSC), Canadian Pacific Railway (CP), and Kansas City Southern (KSU), trades at a slight discount to the S&P 500. The industry’s forward PE (price-to-earnings multiple) of 15.21x is at a slight discount to the S&P 500’s 17.5x.

As mentioned earlier in this series, railroads have underperformed the overall market and have yielded negative returns year-to-date. But the industry has outperformed the market over the last ten years on a total returns basis, with 17.56% annually. The S&P 500 SPDR ETF Trust (SPY) returned 7.7% in that time frame.

It’s worth noting that the S&P 500 also trades at a premium to its historical average of 15.54x, as asset prices in the US have benefitted to a great deal from a low-interest-rate environment.

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CNI, CP, and KSU trade at higher valuations

Comparing the forward PEs (forecast earnings for the following year) of the aforementioned railroad stocks, CNI, CP, and KSU trade at slightly higher valuations than their peers. The forward EV/EBITDA (enterprise value to earning before interest, taxes, depreciation, and amortization) multiple, which removes the effect of leverage, indicates a similar trend.

While CNI, CP, and KSU have had strong margin profiles, their respective dividend yields of 1.6%, 0.7%, and 1.3% are average at best when compared to their Class I peers—NSC, UNP, and CSX—whose dividend yields range between 2.1% and 2.7%.

Investors looking to gain exposure to railroads can consider the SPDR Transportation ETF (XTN) and the iShares Transportation Average ETF (IYT). XTN is a modified equal-weighted index which includes over 48 transportation-sector stocks. It includes five Class I railroad operators:

  • Union Pacific (UNP)
  • CSX (CSX)
  • Norfolk Southern (NSC)
  • Kansas City Southern (KSU)
  • Genesee & Wyoming (GWR) – a short-line regional railroad firm

UNP, CSX, NSC, and KSU constitute ~25% of the iShares Transportation Average ETF (IYT).

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