A RAIL RENAISSANCE THAT
started in 2003 has doubled and tripled share prices of America's largest train operators. Bargain hunters are still buying. Warren Buffett recently took a stake in the No. 1 outfit by market value, sales, recent stock gains and name length:
Burlington Northern Santa Fe
In what follows we'll look at what's fueling the gains and whether a group laggard, Union Pacific, is likely to close in on its peers. It turned up recently in our Three-Point Value screen.
Our screen uses a trio of valuation metrics to look for underpriced shares. Together the three make up for individual weaknesses. A low price/earnings ratio is a good predictor of future stock gains, but earnings can be skewed by accounting adjustments. Sales are more reliable, but the price/sales ratio, like the P/E, can be fooled by a company that's writing up plenty of orders but not collecting much cash. The price/cash flow ratio helps there. Our screen also looks for manageable debt levels, predictions for healthy earnings growth and generally unfavorable analyst opinions a hallmark of value stocks.
Omaha-based Union Pacific serves the western two-thirds of the U.S., with more than 32,000 miles of track in 23 states. The geography gives it more exposure to imports from Asia than from Europe. It also positions the company nicely to carry crops to Asia-bound ships, a business with promising trends. China, for one, looks likely to become a net importer of corn starting in 2008.
The company carries a diverse range of cargo, including cars, industrial products, coal, chemicals and crops. Analysts figure that 57% of its sales base is protected from a downturn in the economy. Union Pacific isn't exactly an efficiency leader. It lags peers in metrics like average train speed and "terminal dwell" cars sitting around. Last year the company cleared 18 cents in operating profit per dollar of sales, vs. an average of 24 cents for the group. But with waste comes opportunity for improvement. The company's latest strategic plan is gradually improving service and asset utilization.
First-quarter results, reported April 19, showed earnings per share jumping 23% year-over-year to $1.41, topping estimates by 13 cents. This, despite bad weather, rising fuel costs and reduced volumes brought on by a soft housing market. Full-year profits are expected to increase 16%, followed by a 15% gain next year. In addition to efficiency gains, the company should benefit from higher prices. Many of its long-term contracts, particularly for coal, are priced up to 25% below market rate, but are due for re-pricing over the next few years.
Six of 17 analysts covering the stock do so with Buy recommendations. John Barnes of BB&T Capital Markets is one of them. He calls railroad valuations "stretched by historical standards." Union trades at 16.4 times current-year forecasts, vs. a five-year average P/E of 14.5. But Barnes thinks the company's earnings could peak at $10 a share in 2009 a 69% improvement in three years. Applying the historical P/E, Barnes sees shares hitting $140 in a year. They go for $112 and change today and carry a 1.1% dividend yield.