There’s a reason Warren Buffett bought an entire railroad to add to his conglomerate of companies. By and far, railroads are one of the best businesses to own because they can generate incredible cash flow and act as a barometer of the economy. While I don’t expect anyone to outright buy a railroad, owning shares of Canadian National Railway Company (TSX:CNR)(NYSE:CNI) could be the next best thing.
Unlike many other railroads, Canadian National is transcontinental, which means that it goes all the way from the Pacific to the Atlantic. Not only that, but it also goes north to south all the way to the Gulf of Mexico in the United States. This is key because it doesn’t have to unload its train cars like other railroads do. Further, it is the exclusive railroad for the Port of Prince Rupert in British Columbia, the fastest-growing port in the world.
That’s good and well, but how is the company doing?
It’s doing better than expected with a slumping commodity market. Due to a 36% drop in coal revenue year over year and low oil prices, Canadian National saw a 9% reduction in revenue primarily because it shipped 12% fewer cars.
But as I like to tell my colleagues, there are two ways to increase profit. You either start at the top of the P&L or you hit the middle; add revenue or cut costs. Canadian National, recognizing that adding revenue right now is not the easiest option, has been making really smart cuts without jeopardizing its growth.
Canadian National increased its margins to 45% (up from 43%) despite a drop in sales. That correlates directly to its operating ratio of 54.5%. Essentially, for every dollar of revenue that the company makes, it costs $0.545. The rest is earnings, so it’s important to keep that ratio as low as possible. The thing is, Canadian National was already the most efficient Class I railroad in North America, and this only makes it that much stronger.
You would think that with all of these cuts, the company wouldn’t really have any room to invest. You’d be wrong. Management explained that it still intends to invest $2.75 billion this year with infrastructure gobbling up $1.5 billion. To keep that operating ratio where it is, it’s important that the railroad continue to make improvements to its infrastructure.
Ultimately, because the company is more efficient, has greater margins, and is investing intelligently, it’s able to distribute its $0.38 per share quarterly dividend. While the 1.79% yield might not be terribly exciting, it has been increasing its dividend as aggressively and safely as it can.
But here’s the bad news…
At $83.90 per share, it’s an expensive stock. It trades at 18.49 price-to-earnings. Had you bought at the end of June, you’d be sitting on really nice returns. Right now though, it’s hard to predict where the price will go from here. If owning a railroad that pays dividends is important, Canadian National is the way to go. But you may want to wait for a better point of entry.
