Riding The Rails: Canadian Train Stocks Preferred To CSX, Union Pacific

U.S. rail stocks may be losing their steam. On Monday, Morgan Stanley analyst Ravi Shanker downgraded CSX Corporation CSX and Union Pacific Corporation UNP and said investors should be hopping aboard Canadian rail stocks Canadian National Railway (USA) CNI and Canadian Pacific Railway Limited (USA) CP instead.

According to Shanker, the U.S. rail industry is headed for a period of intense pricing pressure due to weakening auto and coal markets (see his track record here). The industry is also heading into a period of relatively difficult year-over-year comps compared to the first half of the year.

“We believe volume weakness (driven by secular and cyclical headwinds) will likely occur at a time when the gap between pricing and inflation is narrowing, coinciding with cost cutting efforts (which buoyed Rail results in the last two years) achieving diminishing results,” Shanker wrote.

In addition to coal and autos, Morgan Stanley believes consensus estimates for intermodal, chemical and crude and frac sand demand are overly optimistic as well.

For CSX, Shanker said it will be very difficult for the company to hit its target operating ratio of 59 percent given the weak pricing environment and deteriorating end-markets.

For Union Pacific, Shanker said a spike in coal demand failed to materialize this year, and the stock’s 19x earnings multiple represents a meaningful premium to its historical valuation.

Morgan Stanley now has Overweight ratings for Canadian National and Canadian Pacific, Equal-Weight ratings for Union Pacific and Kansas City Southern KSU and Underweight ratings for CSX Corporation and Norfolk Southern Corp. NSC.

Related Link: The Worst Performing Rail Stock Of 2017: Canadian Pacific