“In a world where things are changing fast / Ain’t too many things that are made to last / Hang on to her, boy / They don’t make them like that anymore”. (Boy Howdy, 1994.)
Trains are the most cost-effective way of transporting goods between the Great Lakes and the West Coast.
Ships offer the cheapest means of transporting cargo. That’s why freighters ply the Great Lakes and St. Lawrence Seaway. But in Canada, they can’t go further west than Thunder Bay. And trucks can’t make long hauls to and from the West Coast pay much. Trucks are better suited to short hauls from, say, warehouses to retailers or in the ports.
On long hauls between the Great Lakes and the West Coast, trains are the most cost-effective way of transporting goods. Fast-growing trade with Asia works to the advantage of trains. Remember, too, that replacing transcontinental railroads is not an option. The enormous barriers to entry has created what billionaire Warren Buffett calls a durable and profitable economic ‘moat’. No wonder that he invested in the railroads. You should too. “They don’t make them like that anymore.”
Buy Canadian Pacific Railway
Calgary-based Canadian Pacific Railway (TSX—CP; NYSE—CP) reported record results in 2018. It expects to earn more this year and next. Keep on buying CP for long-term share price gains and modest, rising dividends.
In 2018, CP earned an adjusted net income of $2.090 billion, or $14.51 a share (excluding one-time items in both years). This was up by more than 27 per cent from adjusted net income of $1.666 billion, or $11.39 a year earlier. CP’s earnings growth was assisted by buying back 4.4 million shares. On January 1, there were 140.5 million shares outstanding.
CP keeps setting new earnings records
This year, CP expects its adjusted net income to grow by “double digits”. The consensus of the analysts is that the railroad will earn $16.37 a share. That would represent healthy earnings per share growth of 12.8 per cent. Based on this estimate, the shares trade at a forward P/E (Price-to-Earnings) ratio of 16.4 times. That seems reasonable for a company that delivers solid earnings growth.
Next year, CP’s adjusted earnings are expected to grow by a dozen per cent, to $18.56 a share. Based on this estimate, the shares trade at an even-better forward P/E ratio of 14.6 times.
CP set records in other ways too. In 2018, its revenue rose by 11.6 per cent, to a record $7.316 billion. It earned more revenue in all nine categories (grain; coal; potash; fertilizers and sulfur; forest products; energy, chemicals and plastics; metals, minerals and consumer products; automotive; and domestic intermodal. (This refers to containers that trains, ships and trucks can carry.) This year the railroad should earn more revenue. It expects to achieve “mid-single digit volume growth, as measured in revenue-ton miles.”
Operating ratio continues to improve
CP improved its operating ratio to a record 61.3 per cent. This year, we expect its operating ratio to improve again. That’s partly due to capital investment of $1.6 billion this year. This is “to enhance the service, productivity and safety of the network.”
CP’s net debt-to-cash-flow ratio is 3.3 times. That’s above our usual comfort zone of two times or less. Still, we find this acceptable given the railroad’s rising cash flow from so many customers. What’s more, the cash flow of $2.647 billion overcame net capital investment of $1.473 billion and dividend payments of $348 million. Excess cash flow of $826 million helped finance net share buybacks of $1.079 billion.
Buy CP for long-term share price gains and modest dividends that have resumed rising.
Keep on buying Canadian National too
Montreal-based Canadian National Railway (TSX—CNR; NYSE—CNI) earned record profits in 2018. It expects to earn more in 2019. And it raised its dividend again. This transcontinental railroad remains a buy for long-term share price gains and modest, but growing, dividends.
In 2018, CN earned an adjusted C$5.50 a share. (Adjusted earnings exclude one-time items in both years, such as lower US corporate income tax rates.) This was up by 10.2 per cent from adjusted earnings of $4.99 a share, the year before.
CN’s earnings growth is accelerating
CN expects its adjusted earnings per share to grow “in the low double-digit range this year”. The market expects the railroad’s adjusted earnings to climb by 15.1 per cent, to $6.33 a share.
Based on this earnings estimate, CN trades at a forward price-to-earnings ratio of 17.4 times. While that’s not particularly cheap, it seems reasonable for a company with solid earnings growth.
CN’s 2018 operating ratio (operating costs to operating revenue) deteriorated by 1.7 percentage points, to 61.5 per cent. This is worse than CP’s operating ratio of 61.3 per cent (the lower the number, the better).
We expect CN’s operating ratio to improve
But we expect CN’s operating ratio to improve this year. President and chief executive officer Jean-Jacques Ruest said: “In 2019, our record capital program of C$3.9 billion will be focused on investing in the renewal of a more efficient and reliable locomotive fleet, adding network capacity to accommodate our solid pipeline of growth in diverse markets and bringing technology to our Precision Scheduled Railroading.” Remember, too, that last year it placed orders for new, bigger and better grain cars. This should assist CN is transporting Canadian grain crops to markets in a more timely manner.
One positive aspect for CN is that it’s the only railroad that serves Prince Rupert’s port on the coast of British Columbia. We think that will pay off handsomely in the years ahead. For one thing, it’s about four days closer to Asia than ports further South, such as Vancouver and Long Beach.
For another thing, Prince Rupert’s port has plenty of spare capacity. That means that ships can quickly unload and reload. In busy ports like Vancouver’s, by contrast, ships have to wait their turns to unload and reload.
In addition, Prince Rupert’s port handles intermodal cargo. More and more cargo is shipped in containers. Ships, railroads and trucks can all carry intermodal traffic. This makes the transportation of intermodal cargo more efficient and less costly.
CN is a ‘dividend aristocrat’
CN has raised its dividend every year since it was privatized in the early 1990s. Since it has raised its dividend in each of the past five years, this transcontinental railroad remains what’s known as a ‘dividend aristocrat’.
CN now pays dividends of C$2.15 a share. This was up by 18.1 per cent from dividends of $1.82 a share, last year. The dividend yields a modest 1.9 per cent.
We expect CN to continue to raise its dividend every year. After all, its growing earnings give it the means to pay more. In addition, CN would not want to mar its excellent dividend record.
Regularly-rising dividends greatly improve your chances of making share price gains in the long run, if not in the short. That’s because the dividend keeps climbing and becomes too good to ignore. This attracts income-seeking investors who will bid up the share price.
CN remains a buy for long-term share price gains and modest, but growing, dividends.
This is an edited version of an article that was originally published for subscribers in the February 8, 2019, issue of The Investment Reporter. You can profit from the award-winning advice subscribers receive regularly in The Investment Reporter.
The Investment Reporter, MPL Communications Inc.
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The Investment Reporter •3/10/19 •