Canadian National Railway Company (TSX:CNR)(NYSE:CNI) offers a full suite of customized services to suit clients’ shipping needs. Transporting products such as grains, fertilizers, coals, metals, and minerals, etc. is an essential part of the economy. Yet from a 52-week high of $88, Canadian National Railway has gone down to $73, a decline of 17%.
Weakness due to slower growth
The price decline is partly due to the anticipated slow growth in the railroad leader. In 2014 Canadian National Railway’s earnings per share (EPS) growth was 23%. At the time, it traded at a fair price-to-earnings ratio (P/E) of 22. However, the growth isn’t continuing at that high rate, so the shares are experiencing multiple contractions.
EPS is expected to slow to 10-13% in the next couple years. So, one can argue that at a P/E of 18, Canadian National Railway is more fairly priced than when it was $88. Just because the price came down doesn’t mean the shares are actually cheaper in a valuation sense.
Dividend growth
However, a lower price does equate to a higher yield. For Canadian National Railway, that means the shares are now generating 21% more income than when it was at $88. The shares now yields 1.7% instead of 1.4%.
With a payout ratio around 30%, there’s a margin of safety for the railroad’s dividend. The company has navigated in slow business cycles before. For 19 years, it has been able to increase its dividends every year at an annual rate of 14-18%.
With anticipated slower growth, investors can expect Canadian National Railway to grow dividends between 10-13% in alignment with its earnings growth. So, if Foolish investors were to buy shares today at $73 with a yield of 1.7%, you can expect 2-2.2% yield from the railroad by 2017. That is, an investment of $10,000 today would generate $200-220 of annual income in 2017.
In conclusion
When we invest in a business, we should be doing it for the long term because short-term stock prices are highly unpredictable. In the short term, the price is based on a weighing machine. If there’s negative sentiment in the market due to a negative economic outlook, for example, most stocks are going to decline in price whether the business is profitable or not.
For a cyclical business such as Canadian National Railway, investors should expect occasional slow earnings growth. Cyclical businesses tend to do well in an expanding economy, and not so much in a contracting one. However, even the anticipated 10-13% growth would be phenomenal for a $53 billion market cap business such as Canadian National Railway’s.
The shares are fairly priced today, but could decline further due to multiple contractions. By buying Canadian National Railway at $73, investors can expect 10-13% growth of their investment in the next few years. If that materializes, that kind of return still beats the general market returns of 7%.
As usual, dollar-cost averaging into a position is generally safer because there’s the potential to buy more shares at a lower price if the current market sentiment leans towards the negative side.
