Valuation multiple for railroads
Railroad stocks are cyclical in nature, meaning they move along with the swings in the economy. Major US railroads are also capital intensive, having high levels of depreciation and amortization, and such companies have varying degrees of financial leverage. This means that it’s wise to value and compare railroads using the EV-to-EBITDA (enterprise value to earnings before interest, tax, depreciation, and amortization) multiple.
Forward price-to-earnings multiple
The PE (price-to-earnings) ratio determines how many dollars the market is paying for every dollar of expected earnings in the next 12 months per share on the stock. A lower multiple might suggest an undervalued railroad, but not always. Railroads with higher risk may also have low valuation multiples.
KSU, the highest trading railroad
The above graph shows that Kansas City Southern (KSU) was trading at a forward PE multiple of 19.5x, the highest in the peer group, on August 26, 2016. Low uncertainty in overall volumes and better relative coal volumes are most likely adding a premium to KSU. Plus, its far reach in the industrial heartland of Mexico ups KSU’s valuation premium in the peer group.
Genesee & Wyoming (GWR) has the second highest forward price-to-earnings multiple in the peer group. The company is currently trading at a forward PE of 18.5x. GWR has announced the acquisition of Providence & Worcester Railroad Company (PWX) on August 15, 2016. GWR expects to integrate PWX’s operations into its Northeast operations, and GWR expects new business opportunities and significant network efficiencies in the long run.
Investors should note that GWR has a history of successful acquisitions that have been accretive to earnings.
CSX, the lowest trading railroad
CSX is currently trading at a forward price-to-earnings multiple of 15.1—the lowest among its peers. Low operating margins and low EBITDA margins among peers have weighed negatively on the company’s valuation premium, and substantial coal exposure has also pulled down the company’s valuation premium in the peer group.