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US Railroads: Have the Hurricanes Affected Their Valuation?

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Sep. 20 2017, Updated 10:38 a.m. ET

US railroads

In 2017, US railroads’ top lines have seen upward momentum for two consecutive quarters, led by higher volumes and pricing gains for some of the commodities they haul. This gain boosted their earnings. Many railroads posted decent year-over-year increases in their per-share earnings. Could the momentum continue?

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Forward price-to-earnings ratios

A company’s forward PE (price-to-earnings) ratio represents the dollars payable today for every dollar of next year’s earnings per share. Whereas US railroads’ forward PE ratios fell in early 2017, they rose after the railroads’ 1Q17 earnings releases.

Genesee & Wyoming (GWR) has the highest forward PE ratio in the Class I peer group, with 23.7x. Its high ratio is mainly due to the recent acquisition of The Heart of Georgia Railroad, for which the synergies have been priced into the stock.

CSX (CSX) has a PE ratio of 23.3x. Markets have huge expectations for CEO Hunter Harrison’s precision railroad modeling techniques. This model is expected to bring down CSX’s operating ratio to the mid-60s, thereby significantly improving the company’s bottom line.

Kansas City Southern’s (KSU) ratio of 20.4x ranks in third place. Among all Class I railroads, Kansas City Southern is expected to benefit the most from a sustained coal bounce back. Mexican energy reforms are also expected to add to the company’s top line. However, investors shouldn’t forget that the stock is the most volatile in the peer group.

Norfolk Southern’s (NSC) forward PE ratio of 20.2x is well placed in the peer group, for which the average ratio is 20.5x. Canadian Pacific Railway (CP) has the lowest forward PE ratio among US Class I railroads (XTN), with 17.2x. Its low ratio may be attributed to the loss of business to competitor Canadian National Railway (CNI). Harrison’s departure from the company to join CSX may have also impacted it.

Conclusion

Based on railroads’ valuation, it’s clear that positive sentiments are still high. Even though the hurricanes may have strained 3Q17 and 4Q17 earnings, the freight volume outlook remains promising on a year-over-year basis. Forward PE ratios suggest that markets may have already factored this volume upside into stock prices.

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