Hop On That Fast Freight

By Mara Der Hovanesian

All Aboard
Railroad stocks have been on a roll all year, partly because of news that champ investor Warren Buffett is buying. The four names that make up the Standard & Poor's (MHP ) rail index have shot up 25% through May 30, but William Greene of Morgan Stanley (MS ) says earnings growth alone may justify a further 35% rise through 2009. He initiated coverage of five North American railroads on May 7, saying that railroads have pricing power, strong balance sheets, and the capacity to raise dividends. Rising cash flows and higher multiples could lead to returns of more than 20% for a few years out, even in a slowing economy, he says. Greene sees Norfolk Southern (NSC )at 70 by 2009, up from 57. And his target for Union Pacific (UNP ), now at 118, is 154.

Daniel Scalzi of Matrix Investment Research in New York adds that Norfolk's profit margins beat 74% of the Russell 3000 stocks, yet nearly 71% of the index trades at higher p-e ratios. He also says Kansas City Southern (KSU ) is well positioned because it runs 1,200 miles of track from Kansas City, Mo., to Lázaro Cárdenas, a port on Mexico's Pacific Coast. That's important because there's a long wait for cargo to unload in California. One big reason: U.S. longshoremen don't work night shifts, which isn't a problem south of the border. "There's a huge bottleneck," says Michael Donahue, also of Matrix. KSU is "providing an interesting alternative that connects from Mexico right to the middle of America." He figures the 40 stock is worth 53.

Note: Unless otherwise noted, neither the sources cited in Inside Wall Street nor their firms hold positions in the stocks under discussion. Similarly, they have no investment banking or other financial relationships with them.

Gene Marcial is on vacation.

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