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Strong demand keeps railways on track Add to ...

What we're looking for

Railway stocks that may be poised to ride the economic recovery higher after a rough second quarter.

What we found

Investors in railways have done rather nicely so far this year, with most of the major stocks rising 10 to 20 per cent. That's despite a bumpy ride in the second quarter, when extensive floods disrupted several parts of the North American rail network.

"We believe that share price volatility in the second quarter was a reflection of investor uncertainty as to the impact of flooding on financial results as well as weaker carload volume growth," RBC Dominion Securities analyst Walter Spracklin said.

Only one of the major companies is in the red so far this year: Canadian Pacific Railway. It is one of Mr. Spracklin's top picks, along with Canadian National Railway and Norfolk Southern Corp. U.S. railroads' carload volume growth rose 3.1 per cent in the second quarter, while their Canadian peers' remained flat.

CP, whose stock is down more than 8 per cent this year, has been the worst affected by flooding. The company, which reports earnings on July 27, was the only railway to post a year-on-year volume decline in the second quarter, and flooding is still complicating its operations.

"The key is that underlying demand is strong - and the structural cost reductions CP has achieved over the past two years are real and have only been masked by the recent flooding," Mr. Spracklin said. "We believe share price volatility around the second-quarter results will provide a very attractive buying opportunity."

The consensus forecast is for second-quarter earnings of 80 cents a share, but Mr. Spracklin prefers a more conservative estimate of 70 cents. He has a $72 price target on the stock.

CN recorded the highest volume growth in the second quarter. Its trains also ran among the fastest and spent the least time waiting at terminals, Mr. Spracklin said. He expects management to update investors in its strategy to gain market share and identify opportunities for increasing revenue at its conference call on July 25. He expects it to report earnings per share of $1.28 and has an $81 price target on the stock, which has risen about 13 per cent this year.

CN has a competitive advantage over its peers because of its operating efficiency and improved customer service, according to CIBC analyst Jacob Bout. He expects volume and price increases to outpace North American GDP growth and inflation. The stock is his top pick for the sector, with a target price of $85 and "sector perform" rating.

For Norfolk Southern, the key issue going forward is likely to be pricing, which has been strong in the first half of the year. Its stock has risen about 18 per cent this year. Mr. Spracklin expects earnings of $1.23 a share, just below consensus forecasts of $1.29, and has a $79 (U.S.) price target. It reports earnings on July 26.


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