Hedge Funds’ Favorite Railroad Stocks Led by Union Pacific (UNP)

Although they may not be high tech, railroad companies can be enormously profitable to own over the long-term. Not only do many railroad companies have wide moats given the capital needed to compete, but railroads also have pricing power over many customers that ensure steady dividend payouts and stock price appreciation.

In this article we’ll take a closer look at the smart money’s five favorite railroad stocks, Canadian Pacific Railway Limited (USA) (NYSE:CP), CSX Corporation (NASDAQ:CSX), Kansas City Southern (NYSE:KSU), Norfolk Southern Corp. (NYSE:NSC), and Union Pacific Corporation (NYSE:UNP), and see how these companies have been performing this year.

Hedge fund sentiment is an important metric for assessing the long-term profitability. At Insider Monkey, we track over 765 hedge funds, whose quarterly 13F filings we analyze and determine their collective sentiment towards several thousand stocks. However, our research has shown that the best strategy is to follow hedge funds into their small-cap picks. This approach can allow monthly returns of nearly 95 basis points above the market, as we determined through extensive backtests covering the period between 1999 and 2012 (see the details here).

#5 Kansas City Southern (NYSE:KSU)

– Number of Hedge Funds Long the Stock (as of March 31): 34
– Total Value of Hedge Funds’ Holdings (as of March 31): $902.92 million

Given the stock’s almost 30% year-to-date rally, it’s not surprising that 34 funds that we track owned shares of Kansas City Southern (NYSE:KSU) at the end of March. Not only did Kansas City Southern wallop the second quarter bottom-line expectations that analysts had for it, with earnings of $1.22 per share routing the estimates of $1.04, but the stock also trades for a reasonable 18-times forward earnings estimates. Quant fund Renaissance Technologies, founded by billionaire Jim Simons, opened a position consisting of 402,600 shares of Kansas City Southern during the second quarter.

#4 Norfolk Southern Corp. (NYSE:NSC)

– Number of Hedge Funds Long the Stock (as of March 31): 35
– Total Value of Hedge Funds’ Holdings (as of March 31): $716.93 million

Analysts are somewhat mixed on Norfolk Southern Corp. (NYSE:NSC), as 13 have ‘Hold’ ratings on it, while eight have ‘Buy’ ratings, and two have ‘Sell’ recommendations. Collectively, the analysts have a consensus price target of $88.25 per share, which is 0.13% below what the stock currently trades for. Atlantic Securities initiated coverage of the stock with a ‘Neutral’ rating on August 11, though it did assign a bullish $104 price target on it. 35 funds in our database were long Norfolk Southern Corp. (NYSE:NSC) at the end of the first quarter, up by three funds from the end of the previous quarter.

We’ll check out three more railroad stocks favored by the hedge fund industry on the next page.

#3 Canadian Pacific Railway Limited (USA) (NYSE:CP)

– Number of Hedge Funds Long the Stock (as of March 31): 36
– Total Value of Hedge Funds’ Holdings (as of March 31): $3.03 billion

Bill Ackman‘s Pershing Square may have experienced a high-profile setback with a certain pharmaceutical company, but the savvy fund was far more fortunate with its major position in Canadian Pacific Railway Limited (USA) (NYSE:CP), which it started in the third quarter of 2011. Shares of the transcontinental railway operator have appreciated by 212% since the end of that third quarter, and have gained over 15% this year. However, they dipped on August 4 when it was reported that Pershing Square had sold off its position in the stock, likely in response to some of its heavy losses in Valeant Pharmaceuticals Intl Inc (NYSE:VRX). Mr. Ackman also informed the company that he will step down from his position on its Board when his term ends as of the company’s 2017 annual shareholders’ meeting. On the other hand, billionaire Ken Griffin’s Citadel Investment hiked its stake in CP by 115% to 505,017 shares during the second quarter.

#2 CSX Corporation (NASDAQ:CSX)

– Number of Hedge Funds Long the Stock (as of March 31): 40
– Total Value of Hedge Funds’ Holdings (as of March 31): $1.13 billion

CSX Corporation (NASDAQ:CSX) is perhaps the most dividend-friendly railroad stock that hedge funds love. Not only does the company pay an annual dividend of $0.72 per share, good for a 2.57% dividend yield, but it also has a low payout ratio of 37.4%. Shares also trade at just 14.6-times forward earnings estimates, substantially lower than the S&P 500’s forward multiple of 18-times. 40 funds that we track were long CSX Corporation (NASDAQ:CSX) at the end of the first quarter, down by five funds quarter-over-quarter.

#1 Union Pacific Corporation (NYSE:UNP)

– Number of Hedge Funds Long the Stock (as of March 31): 54
– Total Value of Hedge Funds’ Holdings (as of March 31): $1.4 billion

With 54 funds tracked by Insider Monkey owning shares of Union Pacific Corporation (NYSE:UNP) at the end of March, the company ranked as the smart money’s favorite railroad stock. Union Pacific shares are up by 19% year-to-date and the stock has an annual dividend yield of 2.39%. Shares were barely impacted by the company’s 19% slide in profit during the second quarter, as freight volume fell by 11% year-over-year, being most heavily impacted by a 21% decline in coal shipments. Revenue also fell by 12% from a year earlier, to $4.8 billion. The company expects the challenging environment to persist throughout the second-half of the year. Billionaire Dan Loeb opened a 1.35 million-share stake in Union Pacific during the second quarter.

Disclosure: None