Canadian railways remain in the enviable position of operating in a fundamentally sound industry surrounded by a deep and vast moat that will keep them sheltered from market troubles, at least in the long term.
Therefore, the railway stocks are high-quality stocks that investors should add on weakness and hold for the long term, benefiting from dividend income, dividend growth, and capital appreciation.
Solid industry dynamics
The railway industry continues to be very well positioned for the long term.
With high barriers to entry, limited competition, and a sustainable demand profile, these companies are in the driver’s seat.
Growing dividends
This business is a solid free cash flow (FCF) business, with the two Canadian railways, Canadian National Railway (TSX:CNR)(NYSE:CNI) and Canadian Pacific Railway (TSX:CP)(NYSE:CP), generating strong and rapidly growing FCF.
CN Rail has a five-year compound annual growth rate (CAGR) in FCF of 12.5%, and CP Rail has a five-year CAGR in FCF of 11.5%.
This has enabled strong dividend increases. CN Rail has a 12.7% five-year CAGR in dividends, and CP Rail has a more than 13% five-year CAGR in dividends.
Momentum
This speaks to the strong momentum that these companies have been seeing on the cost side as well as the revenue side.
CP Rail just capped off another strong year that blew past expectations, as improved pricing and an improved operating ratio (operating costs divided by revenue) boosted results.
CN Rail is investing in increasing its capacity amid near-term congestion and capacity constraints, but it too is benefiting from strong pricing and a strong operating ratio.
Furthermore, CN Rail is investing in an expansion into complementary businesses with its acquisition of transportation company TransX and, more recently, shipping terminal Halterm.
Crude by rail
The rapidly growing crude-by-rail business is driving strong increases for Canadian railways.
What was, in 2017, a 137,000-barrel-a-day business has become a business that is approaching 350,000 barrels a day, representing a more than 150% increase.
The infrastructure problem is here to stay for now, as the minor pipeline expansion plans that will be completed in the short term are insufficient to really solve the problem.
The major projects that will provide big relief are still uncertain, and even if they are approved, they will take years to come online.
Final thoughts
Armed with healthy balance sheets and stable, predictable capital-expenditure requirements, Canadian railways are extremely well positioned to continue to drive increased FCF and shareholder value.
