The Motley Fool

3 Reasons to Consider a Railroad Investment for Your Portfolio

Most investors don’t realize the lucrative opportunity that comes with investing in a railroad stock. On the surface, railroads such as Canadian National Railway Company (TSX:CNR)(NYSE:CNI) may seem like an average, if not boring investment — there’s nothing spectacular in terms of growth prospects, and they have unimpressive dividend yields that fall behind many other companies in the market.

In reality, Canadian National holds massive potential for investors looking at both long-term growth and income potential.

Here’s a look at what sets this railroad apart from every other investment in the market.

Railroads have a massive defensive moat

Railroads have long been considered a key part of the economy, hauling freight from one coast to another. Despite that, a surprising number of investors often take the view that railroads are an outdated relic of the previous century, with little regard for how much freight is still hauled, and what impact on the overall economy that freight has.

Approximately 40% of all freight in the U.S. is hauled by rail. That’s a staggeringly large amount of raw materials, components, and finished products that are moving across the continent to get to distribution centres and ports. In some respects, you could say that railroads form the arteries of the economy.

Canadian National has an advantage that no other railroad on the continent can offer — access to three coastlines. Canadian National’s vast network spreads from Atlantic to Pacific and down the U.S. to the Gulf.

That moat does not appear to be in danger of being ceded to any competitors anytime soon. After a series of mergers back in the 90s, the Surface Transportation Board (STB) set up guidelines for Class 1 railroads such as Canadian National to adhere to with respect to mergers.

To put it another way, the probability of one or more competitors merging to counter Canadian National’s dominance seems unlikely, and the probability of a new competitor emerging is even slimmer, as it would require tens of billions in infrastructure spending and likely over a decade of construction.

In short, Canadian National will continue to enjoy its sizable moat for the near future, which is great news for investors.

Strong results continue to lead to strong growth

Canadian National will provide an update on the fourth quarter early next year, but in the third quarter, the company reported modest growth in several areas.

Net income in the most recent quarter came in at $958 million, representing a 1% decrease over the same period last year, while diluted earnings per share for the same period saw an increase of 2%, coming in at $1.27.

Revenue for the third quarter saw an impressive 7% uptick over the same quarter last year, coming in at $3,221 million. Revenue tonne miles witnessed a 10% increase, and carloadings saw an 11% increase in the quarter.

Free cash flow for across the first three quarters the fiscal year amounted to $2,321 million — a significant improvement over the $1,741 over the same period last year.

A bright future lies ahead

One of the most anticipated advancements in technology is the advent of autonomous driving. This advancement has the potential to completely change how we drive, but the implications for the freight industry are just as significant.

Some critics have been vocal about how autonomous and electric trucking could take a bite out of rail freight over time, particularly when considering the reduced cost of no longer needing a driver for autonomous vehicles and fuel costs for electric vehicles.

That vision is still at least a few years away — likely at least a decade or more.

For its part, Canadian National is investing in infrastructure and capital improvements, with $2.7 billion in spending targeted for 2017 alone. The output of that investment should translate into more efficiency improvements and faster trains with fewer transfers.

In my opinion, investors looking for a long-term growth investment that provides income-producing opportunities should consider Canadian National.

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Fool contributor Demetris Afxentiou 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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