Full Speed Ahead for the Rails

05/14/2008 12:00 am EST

Focus: STOCKS

Tom Slee

Retired- Financial Advisor, Money Manager, Gordon Pape Enterprises LTD

Tom Slee, contributor to Internet Wealth Builder, says railroads should thrive even in a tough economy, and he finds one that’s particularly well-positioned to profit.

Who would have thought it? Railways are having a good year.

They were supposed to be hunkered down, riding out the recession. Instead, the old iron horse is thriving. Surging demand for commodities is more than offsetting a slump in building materials shipments. Even higher energy costs are proving a plus for the railroads. Each jump in oil prices gives them a bigger edge over their gas-guzzling competitors: trucks. Most important, the rails are able to raise rates despite the economic downturn. Their surcharges are sticking.

Yet the stocks are out of favor. US rails had a surge early in the year, but are now stalled. My feeling, however, is that this industry is going to surprise us with some excellent results this year, starting as early as the second quarter.
 
The most important [reason for this] is that the trucking industry is in serious trouble. According to Donald Broughton, [of] Avondale Partners, an astounding 935 US trucking companies went out of business in the first three months of 2008 because of rising fuel costs. It’s likely to get worse as high gas prices trend even higher.

So, the chances are that we will eventually see a reduced trucking industry consisting of large companies charging much higher rates. That provides the railways with a chance to capture market share.

One railroad that I particularly like is Kansas City Southern (NYSE: KSU). It's powering ahead, and the shares, currently priced around $48, already reflect a lot of the good news. However, KSU is poised to have an exceptionally strong year and an even better 2009.

Founded in Kansas City in 1887, KSU operates 3,226 track miles in a ten-state region of the United States as well as 2,645 track miles in Mexico. In addition, it owns a 50% stake in the Panama Canal Railway, a 48-mile track providing ocean-to-ocean transshipments.

It posted strong results in 2007: Revenue was up 5% year over year to $1.74 billion, while earnings jumped almost 50% to $134 million ($1.57 a share), [beating analysts’ expectations]. Management was able to improve the company's operating ratio (the portion of total revenues needed to operate the system) from 81.7% to 79.2% (76.4% in the fourth quarter).  KSU again beat expectations in the first quarter of 2008.

Asset upgrades, a further reduction in the operating ratio, and carload freight rate increases of about 5.5% are likely to offset any slowdown in business activity. Moreover, the Mexican operations give KSU a hedge against a US recession. As a result, the company is expected to earn about $2.05 a share this year and as much as $2.60 in 2009.

Buy Kansas City Southern with a target of $56.

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