A Comparable Analysis of Railroad Stocks
A Comparable Analysis of Railroad Stocks
Disclaimer: This is not investment advice, just one person’s opinion. Always complete thorough analysis on your own before investing and understand the risks associated with an investment.
The focus of this article will be to show how I compare companies to potentially invest in them. I will walk you through how I begin a fundamental analysis of a company’s financials. Before we begin, I will use a lot of jargon and financial ratios, so please check out the vocabulary section at the bottom of the article for definitions.
I chose the railroad industry to look at because it is an easy to understand business, and it is fairly predictable. In addition, railroads could diversify my tech-heavy portfolio and provide strong returns. In fact, Union Pacific wrote in their most recent 10-Q, “we have seen material volume declines from March in autos, intermodal, chemicals, petroleum, coal and metals offset by increases in grain, construction, and pulp and paper products. Demand driven resources will be adjusted to match the volumes and other cost savings initiatives will be implemented in the second quarter”. Thus on the surface, railroads seem to have a potential place in my post-Covid portfolio because so far, they seem to be at least semi-resilient to Covid related demand shocks.
I started my analysis by selecting the largest and most well known publicly traded railroads. I chose, Union Pacific, Kansas City Southern, CSX Corp, Norfolk Southern, Canadian Pacific, and Canadian National. I began by importing balance sheet and income statement data. I then created two tables to compare these companies: one in regard to valuation and another looking at quality.
The valuation table uses trailing 12 month price to earnings ratio (p/e ratio), enterprise value (EV)/sales, EV/EBIT, and EV/EBITDA. The end result of these ratios is to gauge the relative price of the companies compared to their earnings. The quality table looks at debt:equity, leverage, coverage, quick ratio, EBITDA margin, return on assets (ROA), and sales growth. Debt:equity, leverage, and coverage attempt to look at the financial well-being of companies by analyzing their debt levels. The quick ratio looks at cash and cash-like assets relative to upcoming liabilities. EBITDA margin, ROA, and sales growth look at how profitable and efficient these firms are.
Based on just the ratios, and keeping in mind a post-Covid world, the railroads from least to most attractive are Kansas City Southern, Norfolk Southern, Union Pacific, CSX Corp, Canadian Pacific, and Canadian National. Canadian National consistently has the lowest valuation ratios; this means that for every dollar of earnings you are paying among the lowest amounts, and for every dollar of enterprise value, you are paying the lowest amount. In addition, Canadian National has a low amount of debt relative to equity and earnings. For the two years in question, Canadian National has strong EBITDA margin, ROA, and sales growth. The combination of a manageable debt load, and strong profitability as well as efficiency ratios makes Canadian National the strongest ratio railroad, in my opinion. Their one weakness is the low quick ratio, however the company has plenty of earnings to cover interest expense, and it can always issue debt if extra liquidity is needed. The least attractive based on the ratios is Kansas City Southern because it has had the lowest return on assets, and among the lowest EBITDA margins. Kansas City Southern has the highest P/E, EV/EBIT, and EV/EBITDA ratios.
While using financial ratios to value and compare companies is considered “good” practice among finance professionals, it is important to remember there are limitations to ratios. There is a lot of external information that goes into the value of a company in addition to ratios. And much more can affect the future performance of a stock.
Another limitation of this analysis is that the “top 2” – based primarily on ratios – are not available to trade on Invstr. Thus, I am invested in Union Pacific and CSX on Invstr. I like Union Pacific because of its strong profitability and return on assets. Union Pacific also has the largest market cap and has the lowest interest payments relative to its earnings. These two factors give me the confidence to be long regardless of the amount of debt Union Pacific has. I like CSX because of its leading profitability numbers, combined with the highest quick ratio out of the bunch. I am also long CSX because it has the second largest market cap for railroads on Invstr.
Stay tuned for more industry analyses. And follow my Invstr page @robbieb for trading ideas and commentary on events in financial markets.
P/E: Stock Price/Earnings per share. Measures how much you are paying for a dollar of earnings.
EBIT: Earnings before interest and taxes.
EBITDA: Earnings before interest, taxes, depreciation, and amortization.
Enterprise value (EV): market capitalization + preferred equity + minority interest + total debt – cash
EV ratios (EV/sales, EV/EBIT, and EV/EBITDA): Measures how much a company earns relative to the total value of the firm.
Debt:equity: Ratio of how much debt financing a company uses compared to equity.
Leverage (Debt/EBITDA): Measures debt relative to earnings.
Coverage (Interest expense/EBITDA): Measures how many times a company can cover its interest expense with the most recent earnings.
Quick ratio: Check out my article on the quick ratio.
EBITDA margin (EBITDA/sales): Measure of profitability.
ROA (Net income/Average total assets): Return on assets measures how profitable a company’s assets are at producing revenue.