The railroad industry has produced highly compelling returns for long-term oriented investors over the last decades. The business can be cyclical, which means that shares can be volatile, but over a longer period of time the upwards trend in both share prices and dividend payments is very clear.

We analyzed and ranked the top companies in the railroad industry and believe that Kansas City Southern (ticker: KSU) is the one with the most promising outlook right here.

Company Overview           

Kansas City Southern is one of the largest railroad companies in North America. It is focused on the North-South corridor that connects markets in the US with markets in Mexico. Kansas City Southern, whose history dates back to 1887, is currently valued at $9.5 billion.

Kansas City Southern has reported its most recent quarterly results on October 19. The company generated revenues of $700 million during Q3, an increase of 6.5% compared to the prior year’s quarter. Earnings-per-share rose to $1.57, which is 35% more than what Kansas City Southern earned during the prior year’s quarter. A lower tax rate had a substantial impact on Kansas City Southern’s net earnings and earnings-per-share.

Growth Prospects       

Kansas City Southern has a solid earnings growth track record: Over the last decade (between 2008 and 2017) its earnings-per-share rose from $1.86 to $5.17, and 2018 will be an even stronger year: Our estimate for this year’s earnings-per-share is $6.15.

Kansas City Southern’s results depend on the amount of goods that are transported across the US, which means that recessions and economic downturns have a substantial negative impact on the company’s results. This was visible during the last financial crisis, when earnings declined by two-third between 2008 and 2009.

Kansas City Southern sees strong intermodal traffic (due to strong consumer spending) and rising automotive traffic as growth drivers over the foreseeable future. Due to operating the Mexico-US cross-border routes, Kansas City Southern should be able to profit from the opening of new automotive plants in Mexico (by BMW, Toyota, and Mercedes-Benz), as many vehicles that will be produced there will be sold to the United States.

Margin increases (through operating leverage) and share repurchases, which lowered the share count by 4% over the last year, will positively impact Kansas City Southern’s earnings-per-share growth as well, which is why we forecast a long-term earnings-per-share growth rate of 8%.

Valuation, Dividends, And Expected Returns

Kansas City Southern’s shares trade at $93 right here, which is 22% below the stock’s 52-week high of $120. Based on our estimate for this year’s earnings-per-share ($6.15), Kansas City Southern is valued at 15.1 times this year’s profits right here.

Over the last decade Kansas City Southern was valued at a price to earnings multiple of 19 (median P/E ratio), which means that shares look historically cheap right here. Multiple expansion towards the long-term median would positively impact Kansas City Southern’s total returns, but even if the valuation remains this low, total returns would be solid.

Kansas City Southern’s dividend yields 1.6% right here, which is less than the broad market’s yield of 2.1%. At a constant valuation Kansas City Southern would produce total returns of 9%-10% (earnings-per-share growth and its dividend yield). With some multiple expansion Kansas City Southern’s total returns could easily cross the 10% mark, which makes shares look attractive right here.

Final Thoughts

Kansas City Southern looks like the most promising railroad stock right here. It is historically cheap and could easily produce total returns of well above 10% if its valuation expands towards the historic valuation over the coming years.