BMO Says Buy The Dip On Rails

Fadi Chamoun of BMO Capital Markets is bullish on the rail sector and recommends investors buy the sector following a recent dip.

In a research report the analyst noted that the six major Class 1 railroad stocks saw their combined market value fall by $8.4 billion on Thursday following a disappointing earnings report by Union Pacific Corporation (NYSE: UNP).

The analyst continued that rail stocks sold off due to concerns over the pace of pricing deceleration that Union Pacific mentioned in its earnings report. Moreover, the company also suggested that rail cost inflation could rise to around 3 percent in fiscal 2017 from the lower 1.5 percent pace seen this year.

Related Link: Rail Earnings Season Scorecard

The analyst also offered the following bullet points:

1. The sector is currently in the seventh quarter of declining volume on a year-over-year basis but the fact that railroad companies can improve pricing in the current environment places them "in the top tier among major cyclical industries in North America."
2. Weak demand, excess capacity, weak commodity prices and a strong dollar are all contributing to the pressure on pricing. However, volumes and price appear to be at cyclical lows and both should see improvements next year.
3. The fundamentals that are underpinning pricing power are changing.
4. On an adjusted length of haul basis, pricing among the group is "fairly robust."
5. Railroads are expected to deliver strong positive operating leverage and core margin improvement even on volume growth of two percent or less.
6. Fears over the sustainability of pricing power from a historical perspective has shown to be a buying opportunity for investors.

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