Riding the Rails to Profits

03/29/2010 1:00 pm EST

Focus: STOCKS

Elliott Gue

Editor and Publisher, Energy and Income Advisor and Capitalist Times

Elliott Gue, editor of Personal Finance, says the railroads will be a big beneficiary of the economic recovery, and he recommends a rail carrier and an equipment maker.

Rail freight volumes dropped dramatically during the severe economic downturn of late 2008 and early 2009. But cost advantages and superior energy efficiency should enable railroads to win market share over the long haul.

And volumes are already on the rebound; in early March, rail freight volumes hit their highest levels in over a year. Better still, the North American rail industry has slowly consolidated since deregulation. The remaining rails have invested heavily in improving their tracks, discontinued unprofitable routes, and changed service schedules to increase efficiency and cut costs.

Passenger rail demand is especially resilient during economic downturns. In the US, total ridership fell around 4% in 2009, whereas freight carloads dropped 16%. And that decline comes from record levels in 2008, when high energy prices drove many consumers to public transport.

Continued growth in mass rail transit is a global phenomenon. Stimulus packages passed in the US, Europe, and China have included significant funding for high-speed rail. Thanks to all that growth, the Dow Jones Transportation Average has consistently outperformed the Standard & Poor’s 500 index over the past decade.

CSX (NYSE: CSX) serves the eastern half of the country. Close to 80% of CSX’s revenues come from its merchandise and coal businesses. The merchandise business includes fertilizers, ethanol, agricultural products, and steel.

CSX has noted a gradual improvement in volumes transported across most of these business lines since the middle of 2009. With around 30% of its revenue coming from coal, rising global demand for coal should help CSX’s coal business recover.

And CSX’s operating ratio—the ratio of operating expenses to operating revenues—continues to drop as it cuts costs and improves the efficiency and performance of its network. Buy CSX under $53. (It closed around $51 Friday—Editor.)

Westinghouse Air Brake Technologies, now known as Wabtec (NYSE: WAB), manufactures components and equipment used on both passenger and freight railroads. The company’s products includes railway braking equipment, door assemblies, gears, air compressors, positive train control (PTC) systems, and other railway electronics.

In 2009, 42% of Wabtec’s total revenue came from the freight business, two-thirds of which is generated by US operations. Sales of after-market parts constitute two-thirds of the company’s freight revenue. As traffic improves, Wabtec’s after-market parts business will recover gradually.

Several transit systems plan further expansions for 2010, including Miami and Washington, DC. And the US federal government has allocated about $8 billion for spending on high-speed rail and received proposals for more than 200 projects with a total price tag of $100 billion. Wabtec can take advantage as a parts and equipment supplier.

In addition, roughly half of its sales come from outside North America. The company has three separate joint ventures in China and is expanding its manufacturing operations in India to [meet] local demand.

Wabtec rates a Buy under $45. (It closed above $43 Friday—Editor.)

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