Is RailAmerica the little engine that could?

Investors who felt left at the station after Warren Buffett bought out the part of Burlington Northern Santa Fe (BNI) railroad he didn't already own might just have an under-the-radar transportation play of their own.

Tiny RailAmerica (RA) not only enjoys the same economic tailwinds at its caboose as Burlington Northern, but it also has potential upside from consolidation in the highly fragmented short-line and regional rail segment of the industry in which it operates. That's part of Citigroup's (C) thesis, anyway, as analyst Matthew Troy started coverage on RailAmerica at buy with a $16 price target last week.

"Following consolidation in the late '90s, the rails have emerged as an industry with sustainable pricing power that has translated into improving levels of free cash flow and return on invested capital," Troy told clients Nov. 25. True, investors betting on an eventual recovery -- like Buffett -- means most of the easy money in rail stocks has already been made, but RailAmerica has a couple of distinct advantages the bigger boys don't, the analyst argues.

For one thing, RailAmerica's margins are improving at a rate that could exceed its peers as its relatively new management team continues to squeeze operational and cost efficiencies out of its business. Secondly, while pressure in the lucrative coal shipping business could dampen the recovery trajectory at several larger railroads, RailAmerica's coal business is a smaller slice of its revenue -- and has posted better volumes versus the major operators in 2009.

Shares currently trade at 22 times forward earnings, putting them at a less-than-ideal 15% premium to the S&P 500 ($INX). On the other hand, Troy forecasts a three-year growth rate of nearly 100%, which suggest that the price premium is more than warranted. Analysts' average price target stands at $17, according to Thomson Reuters, making the expected return 32% in the next 12 months or so. Given all that and more, "we recommend investors hop on board this train," Troy says.

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