CN: short-term pain; long-term gain

Trade tensions, uncertainty and a weakening economy should weigh on this continental railroad’s cargo volumes, suggesting a weaker profit outlook.


Canadian National’s railway spans Canada from coast to coast and extends through Chicago to the Gulf of Mexico.

Despite a softening economy, transportation stock Canadian National Railway Company (TSX—CNR; NYSE—CNI) delivered strong earnings in its third quarter, beating analysts’ expectations. The company earned an adjusted $1.66 a share, ahead of the average estimate of $1.62.

Revenues for the quarter rose 3.9 per cent year over year to $3.8 billion. The increase was mainly due to freight rate increases and a 13-per-cent rise in intermodal revenues.

RTMs declined; revenue per RTM rose

However, revenue ton miles (RTMs), which measure the relative weight and distance of freight transported, declined 1.3 per cent to 60.8 million. Fortunately freight revenue per RTM increased 5.9 per cent to $5.95, once again mainly driven by freight rate increases and higher intermodal revenues.

Canadian National transports more than $250 billion worth of goods annually for a wide range of business sectors, ranging from resource products to manufactured products to consumer goods, across a continental railroad network of approximately 20,000 route-miles spanning Canada and mid-America.

Earnings growth outpaced revenue growth

For the three months ended Sept. 30, 2019, CN made $1.2 billion (adjusted), or $1.66 a share, compared with $1.1 billion, or $1.50 a share, in the same period of 2018.

Adjusted earnings growth of 8.4 per cent outpaced 3.9-per-cent revenue growth. That’s because CN was able to limit the growth of operating expenses to just 1.0 per cent, thanks to lower fuel costs and record fuel productivity. Consequently, the operating ratio, which measures expenses as a percentage of revenues declined to 57.9 per cent from 59.5 per cent last year (a lower number is preferred).

Strong free cash flow keeps options open

Another metric that did well in the quarter was free cash flow, which rose 19.7 per cent to $700 million. With positive free cash flow a company can do several things, such as raise its dividend, buy back shares, reinvest in the company and make acquisitions.

CN’s strong free cash flow position should stand it in good stead in the final quarter. That’s because North American rail demand has deteriorated as the economy continues to weaken. This has caused the company to lower the company’s financial outlook for the year. In July, it had called for low-double digit growth in this year’s average diluted earnings per share (EPS). Given that its EPS was $5.50 last year, it expected EPS to come in above $6.05 this year. Now it forecasts high-single digit growth.

CN is an attractive long-term investment

Despite the revised financial outlook, we view CN as one of the best railroads in North America given its strong operating record. We, therefore, continue to think it’s an attractive long-term investment.

CN trades at a high but still reasonable 20.6 times its likely 2019 earnings of $5.99 a share. Its annual dividend of $2.15 a share yields 1.7 per cent.

Canadian National Railway is a buy for growth and some income.

This is an edited version of an article that was originally published for subscribers in the November 22, 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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