Are Railroad Stocks Signaling Economic Trouble Ahead?

railroad-stocksAmerica’s railroads are often seen as bellwethers for the broader economy. This reputation is well-deserved, because the railroads are in charge of transporting various industrial and consumer goods all across the country. In a way, railroads are at the heart of economic activity in the U.S.
Because of this, when railroads report poor quarterly results, there’s reason to believe they are signaling broader economic troubles. Last quarter, earnings results were downright ugly from a number of railroads, including Norfolk Southern Corp. (NYSE: NSC) and CSX Corp. (NYSE: CSX).
This begs the question: Is the economy in trouble?
Indeed, both Norfolk Southern and CSX had some disturbing things to say about the state of the U.S. economy. Norfolk Southern did very poorly last quarter. Earnings per share fell 14.5% and badly missed analyst expectations.
Norfolk Southern suffered greatly because of the plunge in commodity prices over the past several months. The company reported lower revenue across several groups, including chemicals, metals and construction, automotive, and paper and forest.
CSX did notably better than Norfolk Southern. CSX’s revenue was flat last quarter year-over-year, and the company managed to increase earnings per share thanks to significant cost cuts and share buybacks.
Still, CSX’s shipment volumes were far from impressive. Agriculture was a problem, as volumes fell 1% year-over-year as a result of weaker agricultural exports. And, like Norfolk Southern, coal was a problem as well. CSX saw a 1% decline in coal volumes. Separately, intermodal volumes were up only 1%.
The fact that weakness was spread across a number of industries should be a concern for investors. It’s not as if the volume problem was isolated in one or two areas. In fact, the declines go far beyond just commodities.
It seems that the first quarter was weak for a number of reasons, including lower commodity prices, extremely harsh winter weather and the rising U.S. dollar, which affected exports.
Indeed, inflation is running dangerously low right now, which may actually compel the Federal Reserve to delay its planned interest rates hikes, initially expected for later this year.
In the meantime, investors need to ask what to do with these railroad stocks. CSX and Norfolk Southern are down 3% and 14%, respectively, in the past six months. If the U.S. economy continues to struggle, it’s likely the railroads will keep reporting weak earnings, which makes it difficult to be very bullish on these names.
One positive note for investors is that both CSX and Norfolk Southern pay strong dividend yields. CSX and Norfolk Southern yield 2% and 2.3%, respectively. And both companies have a track record of raising their dividends over time. This demonstrates that they can still generate cash, even when the top line stagnates.
CSX trades for 18 times earnings, and Norfolk Southern changes hands for an attractive 15 times earnings. These multiples represent significant discounts to the broader market. The S&P 500 trades closer to 20 times earnings.
As a result, value and income investors who don’t mind taking on some risk could see potential buying opportunities in these railroad stocks, due to their cheap valuations and high dividend yields. But as the old saying goes, stocks are usually cheap for a reason.
In this case, the market is clearly worried that the U.S. economy is sputtering. Railroads are highly tied to broader economic growth. On the other hand, the U.S. economy may pick up steam over the latter half of the year, if the weather is better and the dollar rally eases a bit.
It’s important to note that commodities have rallied considerably off their lows. For example, oil is up 33% off its 2015 low in a stealth rally that almost nobody has noticed. This could mean better earnings reports from railroads up ahead.
From a fundamentals perspective, CSX is clearly in better position than Norfolk Southern. That’s because CSX is not nearly as dependent on coal and other commodities.
In fact, not only are CSX’s earnings growing, but it also increased its dividend by 13% after earnings. The company also announced a new $2 billion share buyback program, to be conducted over the next two years.
While railroads are looking shaky right now, CSX remains the industry leader, and the top stock in the sector.

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