I am a tremendous fan of dividend investing and believe that it is one of the surest paths to investing success. Not only do dividends provide investors with a tax-effective income stream, but they are a handy means of boosting returns and reducing volatility.
You see, companies that pay regularly growing dividends typically have mature businesses, wide economic moats, and provide products as well as services that enjoy relatively unchanging demand. Research has also shown that management in these companies take a far more disciplined approach to using capital to ensure the business keeps growing and the dividend remains sustainable.
Canadian National reported some solid results for 2016, including record free cash flow of $2.5 billion and a 3% increase in net income. This was despite revenues falling by 5% year over year because of a 5% decline in car loadings. It is an impressive result given the difficult operating environment caused by a decline in demand for bulk freight transportation because of sharply weaker commodity prices in the first half of the year.
The solid financial performance can be attributed to Canadian National’s ongoing focus on cutting costs, which saw 2016 operating expenses fall by just over 8% compared to a year earlier.
There are signs that the outlook for Canadian National is improving.
Bulk commodities, particularly coal and metals rallied strongly towards the end of 2016, and a range of indicators, including Trump’s planned fiscal stimulus, point to prices remaining firm throughout 2017. This is important for Canadian National because freight by rail remains the only economic means of transporting bulk freight such as coal, ores, fertilizers, lumber, grain, crude, and frac sand.
The recovery in crude also bodes well.
The decline in car loadings over the course of 2016 can be primarily attributed to the slump in oil, which caused output from the energy patch to fall. This impacted the volume of crude transported by rail and demand for frac sand, which is an important ingredient in the hydraulic fracturing process used to extract oil from shale formations.
As oil prices firm, production will increase, sparking greater demand for frac sand and for the transportation of crude by rail because of constrained pipeline capacity.
Investors should not forget that Canadian National possesses an enviable economic moat.
Not only is the rail industry heavily regulated and possesses steep barriers to entry, but Canadian National operates one of the few transcontinental rail networks in North America. Its track network stretches coast to coast across Canada and goes as far south as the Gulf of Mexico. This makes it an integral part of North America’s transportation network, giving it access to 75% of the population.
As a result of the strong performance and improving outlook, management elected to reward loyal investors with a juicy 10% dividend hike that takes effect in 2017. This is the 17th year straight in which Canadian National has increased its dividend payment. Its yield is now a very sustainable 1.7%. Because of the more upbeat outlook, it is likely that Canadian National will reward shareholders with further dividend increases in coming years. For these reasons, it deserves to be a core holding in any stock portfolio.
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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.