A smart way to play high oil prices
Leading railroads Burlington Northern and Union Pacific get a competitive edge when fuel costs are high.
NEW YORK (MONEY) -- High oil prices have been dragging down stocks. And share prices got another kick in the head Monday, when BP announced it would be shutting down the Prudhoe Bay oilfield in Alaska.
The company has detected a dozen possible instances of corrosion on its oil pipeline. And it's likely that the necessary repairs will take several weeks. In the meantime, the shutdown will reduce U.S. oil production by 8 percent.
This has slammed the shares of transportation companies even harder than the broad market. On Monday, the Dow Transports fell seven times as much as the Dow Industrials.
Transportation stocks are highly sensitive to fuel costs, but that shouldn't blind you to opportunities in the sector. Shares of leading railroads, in particular, are very cheap and have excellent long-term prospects.
Given all the trouble in the Middle East, it's entirely possible that oil prices will stay high for some months -- or even spike higher.
From a long-term perspective, however, oil is overpriced. And at some point, it should come back down below $50 a barrel.
Moreover, even though railroads are hurt in the short run, just like other transportation stocks, they are more fuel-efficient than both trucks and air transport.
So they stand to gain market share over the next five to 10 years, no matter what oil prices do.
Leading rails such as Burlington Northern Santa Fe and Union Pacific also profit indirectly from high energy prices because they have sizable businesses hauling low-sulfur coal.
In addition, they are benefiting from new technology. Major railroads are actually very complex information systems that have to keep track of how all the trains are moving, where all the freight is and how all the switches are set.
Sophisticated computer systems can greatly raise efficiency and prevent freight from sitting in rail yards much longer than necessary.
Both Burlington Northern (Charts) and Union Pacific (Charts) are projected to increase their earnings at a superior compound annual rate of at least 13 percent over the next five years. The stocks also offer yields of around 1.4 percent.
Shares of both companies have sold off since May after gaining substantially during the previous 18 months. At a current $67.62, Burlington Northern is now trading at only 12 times earnings projected for 2007. Union Pacific, $80.99, goes for a P/E that's just a tad higher.
Of the two giant U.S. railroads, I'd be inclined to favor Burlington over UP. Both performed well in the most recent quarter. Burlington's earnings per share gained 32 percent on an 18 percent gain in revenues. UP saw a 64 percent jump on a 17 percent revenue increase.
Union Pacific's results may look more impressive, but the company has had greater management problems over the past few years, and recent results are coming off a lower base. Burlington, by contrast, has a better historical record, and seems like an obvious bargain at only 12 times earnings.
Michael Sivy is an editor-at-large for Money Magazine. Sivy on Stocks runs each Tuesday at CNNMoney.com -- sign up to receive it by e-mail.