Rail still has value: analyst
12%Sector Growth

Scott Deveau,  Financial Post 
Published: Monday, January 19, 2009

There's little doubt that, given the current economic downturn, North America's top-tier railways will be announcing some troubling figures when they start to report their quarterly earnings tomorrow. But, for those with a long-term view, any subsequent downward pressure on their stocks could provide an opportunity for investors to climb aboard the rails, analysts say.

U. S. volumes continued their free fall last week, tumbling 17% compared with the same period in 2008 — led by a 70% drop in auto shipments. Canadian volumes were down as well by 27%, led by autos [down 55%] and metals [off 33%].

Even so, North America's Class 1 rails — including both Canadian National Railway Co. and CanadianPacific Railway Ltd. — are still expected to report a 12% year-over-year earnings-per-share growth as a group for the fourth quarter in the coming weeks, according to Rick Paterson, UBS analyst.CNreports on Thursday, while rival CP is the following Tuesday. "However, given the Street has been slow to adjust for the collapse in volumes late in the quarter, and the difficulty modelling the lagged fuel surcharge unwind, the risk of misses is materially higher this quarter," Mr. Paterson cautioned in a note to clients. "We're below consensus — which should continue to fall–for the majority."

Union Pacific Corp. should lead the pack with a 26% EPS growth for the quarter compared with 2007, he said, noting the Nebraska railroad also has the largest upside [94%] with a US$80 price target. UNP closed at US$40.42 on the New York Stock Exchange on Friday.

UBS estimates CN will turn in an earnings per share for the quarter of $1.02, up 13%, while CP will post a profit of $1.10 a share, down 8.3% year-over-year.

Still Mr. Paterson has a "buy" rating on all seven of the top-tier North American railroads.

Likewise, Walter Spracklin, RBC Capital Markets, is encouraging investors to take a long view on the rails and jump aboard on any further share price weakness.

"Despite the current period of economic weakness, we believe that the long-term demand for goods will grow over time and that this will lead to steady and sustainable growth in demand for railroad transportation services," he said in note to clients. He also noted the rails are attractive because there is a high barrier for new entrants, a rational competitive landscape, and the sector continues to take market share from its main competitor, the trucking industry, which is being bogged down by fuel prices, highway congestion and higher operating costs.

"We believe that now is the time to build positions in the railroad segment," he said.

He recommends CN, as the industry's "best-in-class operator," which is currently trading at cyclical lows, and CSX Corp., which reports tomorrow and whose valuation is trading below its peers.