Gene Marcial's Stock Picks August 25, 2009, 5:13PM EST

Marcial: Time to Hop Aboard Genesee & Wyoming?

The lean, niche operator of short-line and regional freight railroads has steered through the downturn handily, kept prices firm, and is well capitalized

http://investing.businessweek.com/services/charts/chart.asp?sym=GWR&d=365&w=600&h=300

Genesee & Wyoming—52-week price

By Gene Marcial

BW's Gene Marcial

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Railroad stocks are starting to gather steam, mainly because of growing optimism that the economy is turning up. Part of the brighter outlook is due to Federal Reserve Chairman Ben Bernanke's assessment that the economy is coming out of its worst crisis in decades. So some pros say this is the time to jump on certain railroad stocks before they pull out of the station.

Bigger isn't necessarily better, however, in picking a potential winner. More important, says analyst George Pickral of investment firm Stephens, are two factors: how efficiently a company has handled the economic downturn and decline in freight volume and how well capitalized the company is.

Genesee & Wyoming (GWR), which operates short-line and regional freight railroads, is one such company, says Pickral. (Stephens has done banking for Genesee.) Generally, investors would go for the so-called Class 1 railroads, major large-cap outfits such as Burlington Northern Santa Fe (BNI), CSX (CSX), and Norfolk Southern (NSC), which dominate the industry.

But Genesee, the only small- to mid-cap investment play in railroads, has its own distinct attraction, operating in a niche market. Headquartered in Greenwich, Conn., it owns and operates 63 railroads in the U.S., Canada, Australia, the Netherlands, and Bolivia. Its railroads primarily transport commodities, such as pulp and paper, coal, minerals, and stone.

"less asset-intensive"

"It tends to do better as the economy recovers because it is leaner and operates more efficiently," says Pickral, who rates Genesee overweight. The stock, which hit a 52-week low of 16.42 on Mar. 9, has ramped up to 31 as of Aug. 24, although it still trades well below its 52-week high of 47 reached about a year ago.

"Genesee & Wyoming continues to offer investors the most attractive way" to play railroads, says analyst John Barnes of RBC Capital Markets. The company, first of all, "offers a model that is less asset-intensive and historically is more capital-efficient than its Class 1 peers." Railroads require "massive capital spending budgets to maintain the track and rolling stock," Barnes notes, so that every year a Class 1 operator will typically spend upwards of $9 billion for maintenance and expansion.

On the other hand, Genesee & Wyoming focuses on a strategy of "build to fit," says Barnes. It hasn't expanded beyond its means, analysts note, and past acquisitions have been well-managed. And like its bigger rivals it has cut costs and has continued to keep prices firm, says Barnes, who rates the stock outperform with a price target of 38.

Even with the first stirrings of an economic turnaround, the railroad industry is by no means out of the woods. Analysts still expect railroad companies to post weak earnings this year, mainly as a result of scaled-down freight traffic. Freight-car originations at major U.S. railroads have dropped steeply this year, according to independent investment research outfit Value Line (VALU). Even so, major rail companies whose cargoes are far less sensitive to economic cycles should continue to book decent profits.