The Canadian National Railway (TSX:CNR) is facing rising costs. Oil prices are rising, employees are demanding higher wages, and it’s all leading to slimmer margins at the railway. Although CNR’s revenue remains fairly healthy, down only slightly from this time last year, earnings metrics are down a lot more. The company’s transportation services are still in demand, but rising fuel and labour costs are eating into its margins. In this article, I will explore whether CN Railway shareholders can count on the company’s dividend being paid in the face of this margin contraction.
Fuel costs on the rise
A big part of why CN Railway’s margins are shrinking is because fuel costs are rising. The price of oil spent much of the summer in a major uptrend. At one point, WTI Crude approached $95, and many commentators expected it to hit $100. Ultimately, that trend broke and gave way to weakness, with oil prices falling to around $82. Prices took another leg up this week though, as fighting between Israel and Hamas raised the spectre of Middle East instability and further OPEC output cuts. So, CN Railway’s fuel costs continue to rise for the time being.
The fuel price increases that CN Railway is experiencing mainly occurred in the third quarter. The second quarter earnings release actually showed a slight decrease in fuel costs. We can infer that the third quarter saw an increase in fuel prices from WTI oil prices and reports by other railroad companies. However, we can’t put a dollar amount on it just yet.
Labour costs rising
Another category of expense that is rising for CN Railway this year is labour costs. Last year, CN Railway workers went on strike to demand higher wages and better work conditions. The strike ended with binding arbitration, likely meaning that an arbitrator decided on a settlement somewhere in between CNR’s position and that of the workers. At any rate, in the second quarter of this year, CNR reported a $66 million increase in labour and fringe benefits. Possibly that was a result of the arbitration between CN and its workers.
A very low payout ratio
Despite the evidence that CN Railway’s costs are increasing significantly, there is one reason to think that the company won’t have to cut its dividend:
Its payout ratio.
A company’s payout ratio is its dividends paid divided by profit earned. Over the last 12 months, CNR’s payout ratio was 38%. That is a pretty low payout ratio, suggesting that even if the company’s earnings decline further, it can probably continue paying its dividend. Were CN’s profit cut by 50%, it would still earn enough money to pay its dividend.
Foolish takeaway
On the whole, I am inclined to think that CN Railway will not have to cut its dividend anytime soon. The company’s earnings are declining, but the payout ratio is so low that the profit decline does not put the dividend at risk. To be sure, rising labour and fuel costs pose challenges to CN as a company overall. But they likely will not necessitate a dividend cut.
