Among the many features found in each week’s edition of Value Line’s Selection & Opinion service is a list of the seven best and worst performing industries over the past six weeks. These rankings can be found on the inside back cover of Selection & Opinion. The roughly 1,700 stocks in the Value Line universe are currently divided among about 100 industries. Notably, for the purposes of calculating these results, the performance of each stock is equally weighted to the others in its industry (i.e., irrespective of market capitalization).  

The six-week period covered in our latest Industry Price Performance rankings was a solid stretch for equities. In all, the Value Line Arithmetic Average rose 3.7% between April 29th and June 10th , and the leading market benchmarks were in the black, as well. Cyclical, economically sensitive industries seemed to generate the most enthusiasm with investors in this environment. The Air Transport group took home the top spot, climbing 10.2% over this stretch. Other groups enjoying strong support in the market were Pharmacy Services (9.3%), Semiconductor Capital Equipment (9.3%), Medical Services (8.9%), Metal Fabricating (8.9%), Homebuilding (7.9%), and Railroad (7.9%).

In looking for investment ideas among these seven industries, we are taking a closer look this week at Railroad stocks. The group’s surge to a leading position in our latest industry rankings was led by Canadian Pacific Railway (CP) and The Greenbrier Cos. (GBX), which advanced 19% and 15%, respectively, during the latest six-week stretch. Investor enthusiasm for the industry, though, is hardly just a recent development. Kansas City Southern (KSU) stock has sputtered this year, likely reflecting the prospect of increased competition in its Mexico operations, but each of the other nine equities in the group have produced positive total returns so far in calendar 2014, with a number showing double-digit gains. Looking farther back, the vast majority of the railroad equities have also outperformed the leading market indices over the course of the current bull market.  

Overall, we think the Railroad Industry will appeal most to investors with a near-term price performance orientation. Indeed, more than half of the stocks in this group are ranked 1 (Highest) or 2 (Above Average) for relative price performance in the year ahead. This includes the aforementioned Greenbrier, which we take a closer look at below. Of the others, Union Pacific (UNP) and Norfolk Southern (NSC) figure to merit consideration by conservative accounts. In addition to being timely, the shares of these two railway operators are also ranked 1 and 2, respectively, for Safety. That said, buy-and-hold investors will need to proceed cautiously, as the healthy share-price gains already racked up across much of the industry leave most of the railroad stocks with below-average appreciation potential to 2017-2019.  

The Greenbrier Companies

The Greenbrier Companies is a leading designer, manufacturer and marketer of railroad freight car equipment in North America and Europe. It also manufactures and markets marine barges in North America, and provides wheel services, railcar refurbishment and parts, leasing and other services to the railroad and related transportation industries in North America. Greenbrier operates in three businesses, Manufacturing; Wheels, Repair & Parts; and Leasing & Services. The largest, Manufacturing, accounts for about 70% of revenues and produces most types of railcars, with the notable exception of coal cars. 

Overall, the company appears to be operating in a generally favorable environment, with increases in rail loadings and decreases in velocity helping to support healthy demand for the company’s railcars. At midpoint of fiscal 2014— year ends August 31st—the backlog stood at more than 15,000 units, with an estimated value of $1.54 billion, up about 8% from a year earlier. Against this backdrop, fiscal 2014 is shaping up as one of the best years in the company’s history. We look for annual revenues to advance 15%-20% this year and surpass $2 billion for the first time. Earnings ought to climb more than 20%, to $2.45 a share, just shy of the previous high of $2.48 reached in 2006. Our early take on 2015 is promising, as well, with sales pegged to climb another 7%, while share net may well surge past the $3.00 mark. 

Meanwhile, increasing regulatory scrutiny of the railroad industry appears to be a trend working in the company’s favor. In particular, governments are moving to address concerns about safety issues, particularly for tank cars carrying oil and other hazardous materials. In Canada, authorities have already issued new rules for phasing out or retrofitting DOT-111 tank cars built before 2011. U.S. regulators seem likely to weigh in on the matter before too long, as well. The need for tank car recertification, retrofit, and repair ought to lead to more work for Greenbrier. To position it to better capitalize on these opportunities, management recently formed a joint venture with Watco to unite the railcar repair, refurbishment, and maintenance operations of the two companies.

Greenbrier stock was the top performing railroad equity during calendar 2013, essentially doubling in price over the course of the year. Support has continued to build since then, lifting the share price another 75% in the subsequent five-plus months. We peg GBX shares to continue to outperform the broader market in the six to 12 months ahead, making them suitable for investors with a near-term performance orientation. On the downside, the stock currently trades at a modest premium to the P/E multiple of the broader market multiple. While not unreasonable, we expect to see some contraction here over the next 3 to 5 years, which limits this equity’s appeal as a long-term holding, in our view.  

Finally, the stock carries a Below Average (4) rank for Safety, meaning investors will be assuming some added risked here. Debt currently accounts for over 40% of total capital, a bit on the high side, in our view, though the company should be able to deleverage some in the years ahead. More concerning is this issue’s very low mark for Price Stability (5 on a scale from 5 to 100), indicating that it has been prone to wide prices from time to time.

At the time of this article’s writing, the author did not have positions in any of the companies mentioned.