Analyst: Class I

Following strong fourth-quarter and full-year 2010 financial reports, Class I railroads “remain compelling investments,” say Morgan Stanley & Co. Inc. transportation analysts William Greene, John Godyn, Adam Longson, and Elizabeth Thys. This is due to several factors:

• Incremental margins and volumes are poised to exceed expectations.

• Sustained momentum on core pricing.

• An upside to current trading multiples.

• Buyback activity is accelerating, so repurchases have emerged as another source of upside over the coming years.

“We continue to favor railroads within our universe of freight stocks,” the Morgan Stanley analysts say. “The 2011 outlook is favorable for railroads. We maintain our above-consensus EPS estimates for most railroads in 2011-12. The consensus is too conservative on forward incremental margins, given the combination of legacy contract re-pricing/price escalators on recently renegotiated contracts, continued productivity gains, and recent volume strength. Early 2011 traffic trends and management/shipper commentary suggests an upside to 2011 volume growth expectations. Continued EPS revisions, and the earnings growth they imply, are likely to drive multiple expansion from current levels. We continue to believe these factors will drive rail shares higher, despite their recent strength. Looking forward, [railroad] management reaffirmed key pillars of our rail thesis: Volume recovery is continuing, albeit at a modest pace; inflation plus pricing growth is intact; and favorable incremental margin trends are likely to continue for many railroads.”