OTTAWA — Riding the economic recovery, North American rail stocks have outpaced broader indexes in 2002, the National Post reports. But how much further the rally has to run is an open question, particularly with Canadian rail share prices that are already approaching or past one-year targets set by analysts only two months ago.
“As you get an improving level of confidence in the economy going forward, people are going to be looking for companies that are going to be benefiting from increased level of industrial output and the movement of goods, and railroads are cyclical beasts to be sure,” said Ted Larkin, an analyst at HSBC Securities Inc.
Since the start of the year the Standard and Poor’s rail index has risen 17.5% versus only a 0.5% return for the S&P 500.
Canadian railways, which are not included in S&P’s sub-index, have climbed more slowly. Canadian National Railway Co. is up 10.8% and Canadian Pacific Railway Co. has returned 6.5%.
Rail stocks are moving even though traffic this year has been relatively weak. In the U.S., carload carryings are down 2.8% while intermodal traffic — an indicator of consumer products being shipped — is down 1.3%. In Canada, the story is similar, with carloads down 5.7% and intermodal off 4%.
Automotive shipments are easing the pain from declines in coal and grain.
Rail stocks are already at the high end of historic valuation levels of 13-to-14 times forward price earnings. At the close of trading yesterday, multiples of the six major Class 1 carriers in North America ranged from 13.5-times at Burlington Northern Sante Fe Corp. to 22.4-times at Norfolk Southern Corp.
Canadian National Railway Co. was up $2.99 to $84.10, giving it a forward PE of 15.2-times and Canadian Pacific Railway Co. was up $1.95 to $34.30, giving it a 13.8-times multiple.
As a result, CN is already at many analysts’ target price. After its fourth-quarter results were released in January, Mr. Larkin put an $81 target on the stock, Rossa O’Reilly at CIBC World Markets gave it an $84.70 target and Fadi Chamoun at UBS Warburg had a $78 target.
CP is also nearing its targets, although it has some room to spare. Mr. Larkin has a $36 target, Mr. O’Reilly $37.70, and Mr. Chamoun $35. Other analysts, such as James Valentine at Morgan Stanley and Gary Yablon at Credit Suisse First Boston, said both CN and CP were at or nearing full valuations more than a month ago.
However, Mr. Yablon also said if railways can raise revenues by improving freight rates rather than simply through increased volumes, then a higher multiple is justified.
“If the industry finally does what it says on the yield front we should see increases in the 1%-2% range that are sustainable. If this does occur rail stock valuations will go to new levels,” he wrote in a report Feb. 22.
As an example, he cited the two U.S. eastern carriers, Norfolk Southern and CSX Corp., as cases where more disciplined pricing is manifesting itself. At the end of yesterday’s trading the carriers both had P/E ratios over 22-times.