Is It Time To Ride Rail Stocks?

According to a recent report, Morgan Stanleyanalysts believe 2015 and 2016 could be big years for U.S. rail companies Union Pacific Corp UNP, CSX Corp CSX, and Norfolk Southern Corp NSC.

Analysts see tight capacity, increasing truck pricing, and inflation as driving forces behind a projected doubling of rail core price growth in 2015.

Trucking Leads The Way

While analysts have no direct indicator of rail capacity utilization, analysts turn to trucking numbers as an indication of what to expect in rails. A recent survey of shippers reveals that industry insiders believe that trucking capacity is now above previous peak capacities reached in 2004 and 2006. Analysts predict similar capacity tightening for the rail companies as well.

Pricing Power

Analysts believe that demand growth will outpace capacity growth for the rails in 2015, and this environment will give the rails increased pricing power. If trucking prices rise four to five percent, rail prices are expected to increase at least that much as well. A large utility company recently told Morgan Stanley that one rail service provider is already asking for a five to ten percent pricing increase in 2015.

Rising Margins

Morgan Stanley analyst William J. Greene makes a strong case for a big boost in incremental margins at the rail companies in 2015. “If we assume ~3% total carload growth, with 50% incremental margins on volumes, mid-single-digit core pricing gains, 2.5% inflation, and then add back productivity headwinds experienced in 2014 as well as incremental productivity gains for 2015, we think incremental margins of 70-90% are achievable.”

Analysts expect the beneficial environment for the rail companies to continue into 2016.