One of the sectors that is the biggest beneficiary of the current economy is railroads. The coronavirus led to a steep drop in spending on certain categories which caused spending to spill over into other areas like housing and physical goods. The latter was also abetted by consumers flush with stimulus.
At the same time, the Federal Reserve slashed rates and injected liquidity into financial markets, this resulted in inflows and increased demand for stocks of companies like railroads with stable businesses that generated yield and who would be able to take advantage of low rates with buybacks.
This positive environment and low rates are also supportive of M&A action as evidenced by Canadian Pacific
Kansas City Southern was pursued by two bidders - Canadian Pacific and Canadian National Railways
It's possible but not likely that CNI will offer a higher bid. Both deals come with assuming about $3 million of KSU's debt.
Outlook
KSU has been one of the top-performing railroad stocks with a 177% gain since the March 2020 stock market bottom. It's also up 53% from its pre-coronavirus peak.
Typically, railroad stocks are cheaper than the market and pay higher dividends. However, this is not the case for KSU as it has a forward P/E of 27 and a dividend yield of 0.9%.
Other railroad stocks have valuation multiples that are in-line with the market average and pay dividends below the S&P 500's yield. Therefore, railroad stocks shouldn't be overweighted at this point in time.
Railroad stocks are good in more defensive markets as their revenues tend to decline much less. And, while they do benefit from stronger economies, some of the gains are offset by higher rates.
This could be an acute risk for railroad stocks - if rates do start rising - as it could lead to outflows into more cyclical and relation stocks.
