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Why Canadian National Railway Company Should Be a Core Holding in Every Portfolio

One of Canada’s most promising growth stocks is its largest rail freight provider, Canadian National Railway Company (TSX:CNR)(NYSE:CNI). While it seems expensive, it is one stock that has shown itself to be relatively immune to the recent headwinds impacting Canada’s economy. It has also had its outlook upgraded recently and it’s easy to see why.

Now what?

Canadian National Railway has the largest and only transcontinental rail network in Canada. It also has an extensive network of track in the U.S. all the way from Canada to the Gulf of Mexico. This gives it a wide economic moat that helps to protect its competitive advantage and boosts demand for its freight transportation services.

The steep barriers to entry including substantial regulatory hurdles, and the required capital investment makes it virtually impossible for other companies to replicate its business.

The advantages this gives Canadian National can be seen when reviewing its 2014 results. During that year rail freight revenues, which make up 94% of total revenue, grew an impressive 15% compared with 2013.  I expect freight revenues to continue growing, with strong U.S. economic growth driving higher demand for freight by rail in North America.

More importantly, I don’t expect the headwinds facing the rail industry to impact Canadian National as hard as its North American peers. This is because it is better positioned to cope with those headwinds and remain relatively unaffected by declining demand for the transportation of commodities, particularly coal and oil.

With coal making up only 9% of its total freight volumes, Canadian National has the lowest exposure to coal as a proportion of total freight carried compared with its peers.

While petroleum makes up about 23% of its total freight volumes, I doubt that falling production in the energy patch will have the impact on the volume of crude it transports. This is because Canada’s oil producers have been battling a lack of pipeline capacity for some time, meaning that unless there is a significant decline in crude production, demand for crude transportation by rail can only grow.

As a result, the recent meltdown in commodity prices and dwindling commodities demand will have a minimal impact on Canadian National’s freight volumes and revenue.

Canadian National is also poised to benefit from sharply lower crude prices, with diesel and other petroleum products key inputs of its operations. Operating expenses will fall, helping to boost its profitability. 

So what?

For these reasons, I expect Canadian National to continue to perform strongly, despite the headwinds that are afflicting the North American rail industry. This should translate into further earnings growth, with investors being rewarded with yet another dividend hike.

In fact, since commencing dividend payments in 1996, Canadian National has hiked its dividend every year since then to give investors a very sustainable 1.3% yield. While this may not be particularly impressive, its compound annual growth rate of almost 17% certainly is, being more than eight times the average annual rate of inflation for that period.

This makes Canadian National a core holding in any portfolio, with its solid dividend growth set to reward patient investors while they wait for its share price to appreciate.

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Fool contributor Matt Smith has no position in any stocks mentioned. David Gardner owns shares of Canadian National Railway. The Motley Fool owns shares of Canadian National Railway. Canadian National Railway is a recommendation of Stock Advisor Canada.

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