After yet another tweet by U.S. president Donald Trump, Canada has become part of a global trade war that may make it more expensive to purchase goods and much more difficult to export them into foreign countries. The writing may be on the wall for investors to make substantial gains from shorting the country’s railroads.
In spite of being fantastic investments, according to Michael Porter’s five forces, we must remain diligent to the realities of life. At the present time, railroads move a very large part of the goods that go in and out of Canada. Should a trade war ensue, and fewer goods are bought and sold between countries, the repercussions could be severe.
Beginning with shares of Canadian Pacific Railway Limited (TSX: CP)(NYSE: CP), investors who are not obtaining capital appreciation will be left with only the dividend yield, which is no more than 1.1%. After a tremendous run, shares of this behemoth are finally in nosebleed territory and are presenting an opportunity to investors — in the short form, as earnings will have major difficulties in growing from here.
As revenues and earnings have trended upwards for many years, the company has been swimming with the tide as the economy has expanded. To boot, cost containment has never been more present. The problem, however, is that once the expectations of per-share profit increases exceed the capacity of the railroad, the inevitable will occur: shares will decline. No matter how you slice it, expectations will not be met!
For investors who are familiar with the history of the typical economic cycle, one of the leading indicators to a recession is very low unemployment — a reality we now face. As a result of this, the railroad will not be able to increase its capacity, as there are simply not enough workers willing to work the overtime necessary to move the goods. For other companies, production may not be enough to meet demand, which will translate to an earnings miss. We’ve seen this story many times over: companies just don’t have the capacity to meet expectations.
Bigger brother Canadian National Railway (TSX: CNR)(NYSE: CNI) is no different, except that the dividend yield may be enough to keep some investors patient for a longer period of time. At a current price of $106 per share, the yield is no less than 1.7%, which is comparable to the risk-free rate of return. The risk, however, is that shares decline in value, and investors see their capital dwindle. Over the very long term, however, investors will be fine.
As is always the case, investors must consider what they are paying in comparison to what they are receiving. In the case of Canada’s railroads, the current offering may not be attractive enough for many to consider. The next 12-24 months, however, could present incredible opportunities for investors to reap large rewards. This industry will need to be followed closely from here.
