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3 Railroad Stocks for Growth and Income

Published 01/29/2023, 01:53 AM
  • Railroad stocks generate steady cash flow that has historically translated to reliable total returns.
  • Union Pacific is positioned to benefit from the growing demand for grains and other commodities.
  • Norfolk Southern has one of the healthiest balance sheets in the industry that should carry growth opportunities for years to come.
  • CNI shares are trading within 10% of their all-time high, but the P/E ratio (combined with the dividend) puts the stock firmly in value territory.
  • The classic train sound is produced by steam escaping the locomotive at each stroke of the engine's cylinder.

    For railroad stocks, it's the sound of escaping 2022 relatively unscathed. The group's 8% decline paled compared to S&P 500's 19% slide. And on the heels of 20%-plus gains in each of the three prior years, the railroad industry keeps chugging along — it is already up 3% year-to-date.

    It's as if Warren Buffett knows what he's doing.

    In an age of artificial intelligence, Internet-of-Things devices, and other emerging technologies, railroad companies are quietly delivering solid shareholder returns. While they lack tech's growth potential, they generate steady cash flow that has historically translated to reliable total returns.

    Investors have several choices regarding railroad stocks, from cargo carriers to service providers and even tech innovators. Buffett's Berkshire Hathaway (NYSE:BRKa) now owns BNSF Railway Company, so there's no direct way to mirror the Oracle (NYSE:ORCL) of Omaha's "invest in what you know" strategy.

    One way to replicate the exposure is to invest in railroads that are "on track" for long-term growth. Even better if they offer attractive dividend yields.

    1. Union Pacific

    Based in Buffett's hometown, Union Pacific Corporation (NYSE:UNP) has been providing rail transportation across North America since the 1860s. Today, its network spans more than 30,000 miles on which agricultural goods, automotive parts, coal, chemicals, and more are shipped from coast to coast and south to Mexico.

    Over the long haul, Union Pacific is positioned to benefit from growing demand for grains, commodities, and products needed for the country's industrial revolution. As input cost pressures subside, profitability is expected to improve in the back half of 2023 and 2024. In Q4 of this year, analysts are projecting a return to double-digit EPS growth.

    Shareholder-friendly is also an excellent way to describe Union Pacific. A dividend has been paid for 123 straight years, increased for 16 straight years, and the 2.5% forward yield is above the sector average. Moreover, the company has a stock buyback program partly funded by debt that supports the stock price during downturns.

    2. Norfolk Southern

    Norfolk Southern Corporation (NYSE:NSC) operates a smaller footprint than Union Pacific, covering 22 eastern states. The company serves all major east coast ports and is linked to partners in the West and Canada. Incoming CEO Alan Shaw is spearheading a newly announced plan to enhance productivity and improve service as a foundation for future growth.

    Investors looking to emphasize the deglobalization trend in their portfolio should lean towards Norfolk Southern. Its rail mileage and intermodal network make it a significant player in the domestic supply chain. As more U.S. companies look to enhance their local logistics in the wake of the pandemic, Norfolk Southern's services will increase demand.

    Last year, management raised the quarterly dividend by 14%, a sign of conviction in the long-term outlook. The current 1.9% yield isn't huge, but given the company's low 33% payout ratio, there is ample room for dividend growth. Norfolk has one of the healthiest balance sheets in the industry that should carry growth opportunities for years to come.

    3. Canadian National Railway (TSX:CNR)

    North of the border, Canadian National Railway Co (NYSE:CNI) is an excellent way to invest in North American economic growth. The reach of its rail network is similar to that of Union Pacific, just on a smaller scale. It hauls a wide range of commodities and goods to manufacturers and end markets and, like Norfolk Southern, has a new leader at the helm.

    Since Tracy Robinson took over as CEO last year, CNI's profitability has shifted into a higher gear. Third-quarter earnings jumped 40%, prompting management to boost its full-year EPS growth forecast to 25%. Contrast this to the consensus expectation for 5% earnings growth in 2022 on the S&P 500.

    In recent periods, CNI has seen accelerated volume growth led by the Automotive, Coal, Petroleum & Chemicals businesses. Meanwhile, operational efficiency is heading higher thanks to improvements in train productivity. Positive trends in volume and profit margins gave management the confidence to raise the dividend by 19%, bringing the yield to 1.8%.

    CNI shares are trading within 10% of their all-time high, but the P/E ratio (combined with the dividend) puts the stock firmly in value territory. The 17x trailing multiple is well below the sector and industry averages, while the 15x forward P/E is low, considering the recent growth. CNN's history of share buybacks is one more reason to climb aboard this growth and income train.

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