The Value Line Investment Survey

Canadian National stock offers favorable 3- to 5-year share-price growth with a decent income component. This premise considers the railroad’s healthy balance sheet and strong cash flow. Canadian National (CN) is the most profitable large railway in North America, and its margins may well widen, given management’s targeted investments. This equity, having a Safety rank of 2 (Above Average), would be a good addition for most conservative portfolios

Improving Efficiency

CN is benefiting from renewed pricing power that railroads are enjoying across the industry. The Montreal-based company has an edge over competitors, thanks to its reputation for top-notch service. Opportunities for net-profit enhancement don’t stop there. Recently signed asset-sharing and routing-protocol agreements with Canadian Pacific will make use of the most efficient gateways on the two companies respective routes. This has the potential to reduce congestion and speed delivery times. Too, CN is investing in the modernization of train terminals. A key one in Memphis is now near completion. Also important, management is endeavoring to close the acquisition of the Elgin, Joliet and Eastern Railway, which would eliminate the most serious bottleneck (in the Chicago area). We look for a final regulatory decision by this fall. Approval would likely prompt us to raise our earnings estimates for CN. If regulators bar the deal, an unlikely outcome in our view, the company would probably use its ample cash reserves to reward investors with sizable dividend hikes and /or stock buybacks.

Near-Term Headwinds

Forest products make up a large share of CN’s total shipments. This segment has struggled in recent times due to the housing downturn in the United States. Exacerbating the situation is a strong loonie, versus the American dollar. Canadian goods have become less competitive, and shipments to the U.S. are slowing. Indeed, the strong loonie may have led to the closing of a large paper mill in eastern Canada. A strengthening Canadian currency has distorted CN’s sharenet comparisons. In the final quarter of 2007, the company reported share earnings of $0.90, up from $0.77 in the yearearlier period. When currency effects are eliminated, however, share net was flat. Severe winter weather in Western Canada has pressured the current quarter’s performance. And broader economic weakness will probably restrain revenue and net-profit growth over the next few reporting periods.

Long-Term Potential

Last October, the first construction phase of a new container terminal at the Port of Prince Rupert was completed, creating the fastest shipping route between Asia and North America. CN is the only railroad operating at this port, which should gain much market share from other severely congested terminals further south. To support outgoing shipments from the continent, CN has invested in a new terminal at Prince George. Separately, in the past two years, the company acquired three short line railways in Alberta. High oil prices have made oil sands production economical, and boosted transportation needs in the region. Rail system spending will be quite heavy in the near term, but the return on investment should become very favorable as Alberta’s import/ export volume rises in the coming years

In sum, despite some short-term macroeconomic pressures, Canadian National shares offer conservative investors worthwhile total returns over the pull to 2010-2012. Cash flow is more than sufficient to cover required annual spending outlays and to provide regular dividend increases. The company’s debt ratio is below the industry average.

Craig Sirois
Senior Industry Analyst