CN Rail (TSX:CNR) or CP Rail (TSX:CP): Better TFSA Buy?

CN Rail Co. Ltd. (TSX:CNR)(NYSE:CNI) and CP Rail Ltd. (TSX:CP)(NYSE:CP) just pulled back modestly, but are the dips buyable?

| More on:

What a glorious run it’s been for shares of CN Rail (TSX:CNR)(NYSE:CNI) and CP Rail (TSX:CP)(NYSE:CP) over the past several months. Both major railways will play a major role in lifting the Canadian economy out of its funk over the next several quarters.

With volumes likely to pick up traction into 2021, I think the recent dip in both rail stocks are buyable for TFSA investors looking for excess risk-adjusted returns as the world looks to recover from the coronavirus crisis. But which, if any, is the better buy for your TFSA portfolio at this juncture? Let’s have a closer look at each name:

CN Rail

At the time of writing, CN Rail stock is down just shy of 9% from its high due to what I believe is a massive overreaction to the firm’s sub-par quarterly results, which doesn’t appear to change the 2021 recovery trajectory.

While CN Rail stock’s valuation may have gotten ahead of itself going into the quarter, the name is worthy of a premium multiple as the stage looks set for a big revenue bump alongside what could be a huge improvement to its operating ratio, which, as you’d expect, has dragged for most of the year thanks to the disruptive crisis.

CN Rail is known as North America’s most efficient railway for a reason. Why the firm’s operating ratio (OR) deterioration may be concerning to some, I think the firm will have little trouble getting its OR back down to the mid-single-digits coming the coming year.

Even after the recent correction, CNR stock still looks pricy at 21.3 times next year’s expected earnings and 7.0 times sales. Given the upside to be had in a 2021 economic recovery, though, I’d say the slightly less frothy premium price tag is well worth paying, especially given the relative degree of downside protection you’ll get from the name if next year’s recovery ends up being far rockier than most are expecting.

CP Rail

CP Rail stock has retreated alongside its peer, with shares now down 5.6% from its high. The number two Canadian railway has done a magnificent job of staying operationally efficient (58.2% operating ratio as of the last quarter) despite the profound pressures brought forth by the coronavirus crisis.

The railway’s free cash flow (FCF) took a step back but is poised to bounce back abruptly next year alongside the Canadian economy. Management recently raised its 2020 guidance modestly and is now calling for at least mid-single-digit EPS growth.

At the time of writing, CP stock trades at 20.1 times forward earnings, and like CN, 7.0 times sales. CP has a lofty premium multiple that bakes in a strong economic recovery in 2021. Kay Ng, my colleague here at the Motley Fool, thinks that CP Rail is a better buy than CN Rail because of higher nearer-term EPS growth expectations.

Is CN Rail or CP Rail the better rail stock to buy for your TFSA right now?

Kay and I have agreed with one another on numerous occasions in the past. But this time, I’m afraid I have to disagree when she says CP Rail is the better rail stock to buy here.

CN Rail, I believe, is the far better bet following its 9% dip, as I see greater potential for margin improvement over the year ahead (CN’s OR swelled to 60%, but looks poised to revert to the mid-50s). Moreover, CN’s earnings bar looks to be that much lower following its brutal recent post-earnings flop.

As such, I think CN Rail stock is a far better bet and think shares have greater upside potential versus the likes of its smaller brother over the next 18 months.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Joey Frenette owns shares of Canadian National Railway. David Gardner owns shares of Canadian National Railway. The Motley Fool owns shares of and recommends Canadian National Railway. The Motley Fool recommends Canadian National Railway.

More on Stocks for Beginners

woman looks at iPhone
Dividend Stocks

Retirees: Is TELUS Stock a Risky Buy?

TELUS stock has long been a strong dividend provider, but what should investors consider now after recent earnings?

Read more »

coins jump into piggy bank
Stocks for Beginners

Is Laurentian Bank Stock a Buy for its 6.5% Dividend Yield?

Laurentian Bank stock may have a stellar dividend yield, but there are several risks involved with taking on this stock…

Read more »

space ship model takes off
Stocks for Beginners

2 Superior TSX Stocks Could Triple in 5 Years

If you seek a TSX stock that's going to triple in share price, you need to dip in deep. So…

Read more »

Asset Management
Dividend Stocks

3 Safe Canadian Stocks to Buy Now and Hold During Market Volatility

These Canadian stocks offer the perfect trio for investors looking for growth, income, and long-term holds.

Read more »

four people hold happy emoji masks
Stocks for Beginners

The Smartest Growth Stock to Buy With $5,000 Right Now

This top growth stock has been climbing not just this year, but for years on end! And it's not about…

Read more »

open vault at bank
Stocks for Beginners

Are TD Stock and BNS Stock Smart Buys for Canadian Investors?

TD stock and Scotiabank both delivered earnings this week, so let's look at whether now is the time to buy,…

Read more »

A close up color image of a small green plant sprouting out of a pile of Canadian dollar coins "loonies."
Dividend Stocks

Billionaires Are Selling Lululemon Stock and Picking Up This TSX Stock

Here's why some are parting ways with their athleisure darlings and choosing this dividend darling instead.

Read more »

Investor reading the newspaper
Stocks for Beginners

3 Growth Stocks to Buy and Hold Forever

The best growth stocks are those you can buy and hold for years and maybe even decades. Let these great…

Read more »