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3 Railroad Stocks to Buy Now, 1 to Sell

March 01, 2012 | About:

The railroad stocks below deserve a second glance for their ability to take advantage of diversifying their revenue streams and expanding operations. Revenue diversification in terms of the railroad industry is defined as an expansion of products and services into new markets through partnerships, acquisitions and innovations. A clear example of this would be Pacer International's expansion of intermodal service to provide Chihuahua, Mexico, with links to markets in the U.S. and Canada. While the first three companies discussed below demonstrate how these approaches might determine growth opportunities and overall success for railroad businesses, I've included one at the end that I think shows how failure to branch out can lead to problems for the company. In the face of potentially difficult market conditions that favor environmental friendliness, the most likely candidates for railroad investors are the ones with enough diversity to sustain multiple streams of revenue. With that in mind, I suggest that those companies who provide railroad services just might be more valuable than they first appear.

LB Foster (NASDAQ:FSTR) only has a few days to go before it announces its fourth quarter 2011 operating results and investors are waiting with bated breath to decide their next move.

The new CEO and president, Robert P. Bauer, is a good catch for the company, in my opinion. His history with Emerson Climate Technologies (EMR) shows that he might be the right guy to sustain growth without increasing organizational expenses for marketing or extra staff.

Recently, LB Foster won two awards, one in November of last year and the other on January 11, which I will detail below. About 45% of the company's revenue comes from rail products, with about 50% from construction products, including joints, fasteners, piling and pipes. The rail products plant in Pueblo, Colo., received IndustryWeek magazine's 2011 Best Plant Award, along with nine other facilities around North America.

The remaining 5% of revenue derives from tubular products, and LB Foster's other recent award came from its steel pipe coating facility in Birmingham, Ala. The Alabama Productivity Center presents its annual Alabama Excellence Award for performance innovations in manufacturing. This is a Level Three award.

With these shiny recommendations under its belt, I see no reason why the company should not maintain its hold on the railroad market.

Even though the company is relatively small, with a market cap of about $240 million, its revenue for each quarter over the past three years shows a definite upward trend. Its gross margin spiked and then dropped again in 2009 but has otherwise risen steadily over the long term. Gross, operating and net margins have all been increasing since the beginning of last year.

Sources suggest this rise in profitability stems from operations and not some sort of financial hoop-jumping game.

Pacer International (PACR) has already announced it fourth quarter results, with a near tripling of income from operations. This represents a jump from $3.2 million to $4.2 million.

However, overall revenue was lower than projected, but GAAP earnings per share went up compared to 2010. Earnings per share for the fourth quarter stood at $0.03, a drastic shift away from the $0.19 EPS of the third quarter, but a full $0.06 higher than the prior-year fourth quarter.

Although Pacer's track record is a little shakier than that of LB Foster, my suggestion would be to hold for now. The majority of investors are happy with the stock's performance in the past, according to The Motley Fool CAPS Community, where shareholders can rate companies according to their personal satisfaction levels.

Pacer's focus lies in international trade services, as evidenced by the company's expansion last fall of its intermodal service to provide Chihuahua, Mexico, with links to markets in the U.S. and Canada. The company continues to reach into new markets, which could produce greater profits over the next three quarters if it maintains low operating costs.

American Railcar Industries Inc. (NASDAQ:ARII) deals in hopper and tank railcars and provides management and repair services within the railroad industry. As of close on February 17, the company's market cap stood at $654.66 million.

In December, the company NASDAQ:ARII)%26format=html%26comments=0">announced its intention to expand into the railcar leasing market in partnership with its affiliate American Railcar Leasing LLC. This move could be a sign of uncertainty, but I believe it is a step in the right direction for shareholders. A diversified business decreases the degree of risk it faces should a particular segment of the market fail.

While fourth quarter results are still unknown to the public, last year's third quarter total revenue doubled from the previous year, with a total of $125.8 million compared to $64.8 million in 2010. At close on Friday, February 17th, ARI was trading at about $31, which is very close to the 52-week high, and a far cry from the 52-week low, which was $13.68.

Even with the company's efforts to diversify, it seems unlikely to me that profits will go up much more in the near future. For those who bought in before the company's value went up, now might be a good time to sell, if you want to make a quick profit. I expect share prices to drop in the near future, although I doubt this drop will be dramatic enough to warrant any panic.

FreightCar America (NASDAQ:RAIL) could be on the rise again, having apparently recovered from its 2011 third-quarter depression, when shares were at their lowest in a decade. One reason for this appears to be the mild winters and increased use of natural gas and other fuels as opposed to coal.

Coal mining companies are facing difficult market conditions, and since Freightcar America specializes in aluminum coal-hauling cars, it has been feeling the pinch. However, in light of these conditions, the company has changed its focus to aftermarket parts and refurbishment.

It seems doubtful to me that this strategy will be enough to pick up the company's growth, but at the same time, intelligent diversification comparable to ARI's, as discussed above, could provide the impetus needed to breathe fresh life into a company that seems to be tunnel-visioning at this point. Until we see a shuffle in management, production, or even ideas, however, it is anyone's guess how long FreightCar America is going to last.

This is the only one of the four stocks in this essay that I strongly recommend selling. That being said, the company's recent upswing could be a sign of things to come, if it plays its cards right.

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