If investors just look from the perspective of current income from the two dominant rail operators in Canada, they’re unattractive particularly in today’s higher interest rate environment. However, they could still be good total-return investments.
Moreover, Canadian National Railway (TSX:CNR) has a fabulous dividend-growth streak. While Canadian Pacific Kansas City Railway (TSX:CP) has been less consistent with its dividend increases, it has compensated investors with greater growth.
This higher growth has translated to higher returns for investors. And with a bigger sum of money compounded from a long-term investment in CP versus CN, investors could very well exit the position at one point for bigger income elsewhere.
Let’s make a closer comparison.
Dividends
CN Rail has increased its dividend for 27 consecutive years with three-, five-, and 10-year dividend-growth rates of 10.9%, 12.2%, and 14.6%. At $163.41 per share at writing, it offers a dividend yield of just over 1.9%. Its sustainable trailing 12-month (TTM) payout ratios were 39% of net income and 51% of free cash flow.
CP Rail’s three-, five-, and 10-year dividend-growth rates are 6.6%, 11.7%, and 10.9%, respectively. At $111.04 per share at writing, it offers a dividend yield of just under 0.7%. With such a low payout, you can guess that its payout ratios are lower than CN’s. Specifically, its TTM payout ratios were 20% of net income and 27% of free cash flow.
Growth
In the past decade, CN Rail increased its adjusted earnings per share (EPS) at a compound annual growth rate (CAGR) of 10.3%. In the same period, CP Rail increased its adjusted EPS at a CAGR of 15.8%.
The railways tend to reinvest a little more than 40% of their operating cash flow in capital investments for long-term growth. In the past three years, CN Rail reinvested 43% of its operating cash flow versus CP Rail’s 45%.
CP just merged with Kansas City Southern in April in an epic deal that expanded its operations into Mexico, which should increase its competitiveness. So, it’s possible that its EPS growth rate will continue to outperform CN’s over the next five years.
Valuation
Before investors jump in CP for growth, it’s important to point out that other than the growth rate of the company, the valuation you pay for as an investor matters, too. For instance, CP is anticipated to have higher growth, but investors are paying a higher price-to-earnings multiple for the shares at the present time versus CN.
Currently, CN Rail trades at about 21.5 times its blended earnings with an estimated EPS growth rate of 8.2% per year over the next three to five years. In comparison, CP Rail trades at approximately 28 times blended earnings with an estimated EPS growth rate of 13.4%. However, when we observe their PEG (price-to-earnings-to-growth) ratios of about 2.6 and 2.1, respectively, they indicate that investors would be paying a lower valuation for growth when investing in CP.
Notably, during recessions, railway stocks tend to experience a market correction that could witness declines of 15-30%. If they do experience these kinds of corrections, investors should start being greedy in these wide-moat stocks.
Investor takeaway
Other than providing more dividend income, CN Rail stock also offers greater stock resiliency. In the past 10 years, an initial $10,000 investment in the dividend stock would have returned about $3,610 in dividend income versus $1,972 from CP. Also, in the worst year, CN Rail stock only declined 2%, whereas CP fell a whopping amount of 20%. In the 10-year period, though, CP stock delivered total returns of roughly 18.6% versus CN’s 15.1%.
In other words, CN Rail has more qualities of a good dividend stock — higher dividend income and greater stock resiliency. In contrast, CP should be viewed as more of a growth stock.
