Railroad Industry News

Financial News -Morgan Stanley: Railroads a "solid defensive play"

 

At their current prices, especially with recent sell-off activity in a bear market, railroad stocks are still attractive and "the solid defensive play in transportation," say Morgan Stanley analysts William J. Greene and Adam Longson in a report issued today. "Cautious 2008 guidance on upcoming earnings calls may offer a nice entry point for investors worried they are late to the story. Railroads offer growth outside the normal Gross Domestic Product cycle through pricing power, growing share buybacks, and improving productivity."

Though a mild recession is predicted for the first half of this year, Greene and Longson expect railroads to post 10% to 25% earnings per share this year, and rising returns and free cash flow, even in a U.S. recession. Why? "Railroad pricing is solid, a key pillar to earnings growth," they say. "2007 was a freight recession, so 2008 volumes should hold up better. Rail management is adding debt and buying back shares to boost returns."

Long term, "improving returns and expectations of a 2009 economic recovery hint at possible multiple expansion," Greene and Longson say. "Assuming more normal U.S. GDP growth in 2009, we see 15% to 40% upside by year-end 2008 in our base case. Increased volatility over macro concerns offers potential buying opportunities, in our view."

Greene and Longson's top pick for a slower growth scenario is Union Pacific, with its "diversified portfolio and substantial EPS growth from legacy contract repricing and improving operations." They also favor CN "as low-risk way to play the group," and are swapping CN (overweight) for Norfolk Southern (now equal weight). "Both look cheap, but we see few near-term [growth] catalysts for NS, while CN can potentially post better volume growth in 2008 than any other railroad."

"With today's economic uncertainty, we expect railroads to be conservative with their 2008 guidance," the analysts conclude. "We don't see any catalyst prior to fourth-quarter earnings. Rail traffic will be monitored closely in 2008 for any indication of macro trends, and holidays and weather will continue to obscure underlying traffic trends for the next few weeks."

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