Boring goes a long way in long-term investing. Mature companies with slow-but-stable earnings growth have notably outperformed broader markets in the past. Leading railroad stock Canadian National Railway (TSX:CNR) is an apt example. Including dividends, it has returned 14% compounded annually in the last 10 years, beating TSX stocks.
Investment rationale
Even if markets do not look well positioned in 2023, CNR stock will likely play relatively well due to its strong fundamentals. Its unmatched rail network and efficient operations have facilitated stable earnings growth over the years.
Importantly, CNR’s freight revenues are derived from seven commodity groups, highlighting a diversified revenue base. Its relative undervaluation, stable dividends, and visible earnings growth make it an appealing bet in these uncertain times. Plus, the industry has high entry barriers, which make disruption from a new entrant nearly impracticable.
Financial growth
Railroad operations have a strong correlation with broader economic activity. Even if we see an economic downturn this year, rail companies like CNR will likely witness a limited impact due to their stable business model.
In the last 10 years, Canadian National’s net income has grown by 8% compounded annually. That may seem short against some fast-growing companies. However, mature companies like railroads or utilities grow very slowly and, thus, offer a low-risk, moderate-return proposition.
CNR displayed decent margin stability in the same period, despite its cyclical nature. Its operating margin was in the range of 40%-45%, implying the company’s greater control over costs.
Moreover, CNR has a sound balance sheet with decent liquidity and manageable debt. At the end of 2022, it had net debt of $15.5 billion and a debt-to-equity ratio of 0.7x.
Dividends and buybacks
CNR expects low single-digit per-share earnings growth in 2023 due to a softer economic outlook. Despite an impending slowdown, management has declared an 8% increase in shareholder payouts, implying its confidence in future earnings growth.
CNR stock currently trades at a dividend yield of 2% and recently marked a 27th consecutive year of dividend increases. CNR management also recently announced a buyback of up to 32 million of its shares in the next 12 months. Share buybacks generally indicate that shares are undervalued from management’s perspective. Moreover, it also results in an increase in per-share earnings and boosts the share price in the short term.
Peer comparison
Railroads in North America is an oligopolistic industry dominated by CNR and its peer Canadian Pacific. CP stock has notably outperformed CNR, returning 17% compounded annually in the last decade. It yields 0.7%, lower than CNR. On a valuation basis, CNR is discounted and trading at 20x earnings.
Runaway value
CNR will likely continue to grow steadily, driven by its strong operational execution and broader economic growth. Its relative discounted valuation, buybacks, and stable dividends could continue to drive stable shareholder returns in the long term.
