US railroads and the Tax Cuts and Jobs Act
In addition to US railroads operating in an oligopolistic environment, the railroad industry is cyclical. The industry’s performance assumes significant importance as it throws light on the country’s overall economic activity.
Transportation stocks are in focus due to beneficial provisions in the Tax Cuts and Jobs Act. The lower tax rates could result in higher cash flows for these companies. The increased cash flows can be put to use for multiple options such as higher capital expenditures, higher stock buybacks, or initiating stock buybacks and debt repayment.
Capital-intensive industries like railroads must engage in a balancing act while assessing their dividend strategies. Because railroads don’t depend on the government for their capital asset–related requirements, they must spend their own funds. This has curtailed the dividend-paying abilities of railroads in the past.
Railroad companies retain most of their earnings, leaving little room for dividends. However, the capex-related provisions in the Tax Cuts and Jobs Act have the potential to change the way railroads make their financing decisions. The recently introduced ability to take a tax deduction on the entire capex in the year it was incurred has the potential to support railroad stocks.
The price movement in the last five years
A quick look at the chart above reveals that railroad stocks were up in 2014 due to strong top-line growth. Railcar traffic, including intermodal units, was strong in that year—one of the best years for railroads since the financial crisis.
On an indexed level, with the exception of Eastern US majors CSX (CSX) and Union Pacific (UNP), other railroad stocks appear to be similar to 2014’s peak. We’ll take a look at the five-year absolute returns generated by these stocks:
- CSX: ~130.5%
- Norfolk Southern (NSC): ~79.8%
- Kansas City Southern (KSU): no change
- Union Pacific (UNP): 90.7%
- Canadian National Railway (CNI): 46.2%
- Canadian Pacific Railway (CP): ~36.0%
- Genesee & Wyoming (GWR): -21.5%
The SPDR S&P Transportation ETF (XTN) is an indicator of the broader transportation sector. During the same timeframe, XTN’s absolute return was ~94.0%.
In this series
In this series, we’ll focus on free cash flows, capex levels and the 2018 dividends by the US Class I railroads.