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Why Canadian National Railway (TSX:CNR) Raised Its Dividend by 18%

On January 29, Canadian National Railway (TSX:CNR)(NYSE:CNI) investors were treated to a welcome surprise, as the company increased its quarterly dividend by 18% to $0.45 per share. The dividend increase follows a five-year period of steady payout growth for the company, whose annual increases have averaged about 16.8%. For most companies, 10% annual dividend growth is high. 16.8% average dividend growth easily puts CN in the upper echelon of dividend growth stocks, while the recent 18% increase is leagues above the norm.

Although most CN investors are likely happy about the big dividend boost, it’s worth asking why the company raised it so much–and whether such big increases are sustainable going forward. We can start by looking at the rationale given by CN’s management in the company’s recent reports.

Financial health

In the 2019 Outlook and Shareholder Distribution” section of CN’s Q4 report, management cited financial health as the main reason for raising the dividend. In the same report, the company announced it was prepared to buy back up to 22 million shares, indicating that management is putting its money where its mouth is. And indeed, the company’s financial health does appear sound, with steady growth and $41 billion in assets (compared to $11 billion in long-term debt).

Strong revenue growth

In Q4, CN continued its steady revenue growth streak with a 16% year-on-year increase. This is a typical figure for CN, whose sales are growing phenomenally quickly for a 100-year-old company. Although 16% revenue growth is nowhere near what you’d see in the cannabis or tech sectors, it’s a very healthy figure for an established dividend-paying stock.

Sky-high adjusted EPS growth

On the topic of growth, in Q4, CN’s adjusted EPS growth was ahead of even its revenue growth, at 24%. Although the company’s GAAP EPS slid by 55%, the adjusted figure is probably more reliable because Q4 2017 had a one-time tax recovery that boosted earnings for that quarter unusually high. It’s normal for companies to exclude these figures from adjusted earnings because they’re not expected to recur in the future.

Can it continue?

It’s clear that CN’s 18% dividend increase was a major benefit to shareholders. But can the company keep up such steady payout increases in the future?

When considering questions like the one above, there are two figures you have to consider: earnings growth and payout ratio. Earnings growth means increases in bottom line profitability metrics, like net income and diluted EPS. The more a company’s profits grow, the more it can increase its dividend because it has more funds to do so. Payout ratio is the percentage of earnings paid out as dividends, which is important because it shows how much room a company has to raise its dividend without increasing earnings.

By both metrics, CN’s dividend appears poised for future growth. As mentioned, the company is growing adjusted EPS by 24% year-over-year, which is enough to sustain dividend increases in excess of 18%. The company’s payout ratio also suggests room for dividend growth: at 31%, it’s just a fraction of total earnings.

Al in all, CN is well positioned for more dividend increases going forward.

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Fool contributor Andrew Button has no position in any of the stocks mentioned. David Gardner owns shares of Canadian National Railway. The Motley Fool owns shares of Canadian National Railway.

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