Canadian National Railway (TSX:CNR) is down 11% in 2023 and currently trades close to its 12-month low. Contrarian investors are wondering if CNR stock is now undervalued and good to buy for a self-directed Registered Retirement Savings Plan (RRSP) or a Tax-Free Savings Account (TFSA) portfolio.
CNR earnings
CNR just reported Q3 2023 results that came in weaker than the same period last year. Total revenue was $3.99 billion compared to $4.51 billion in the third quarter (Q3) of 2022. Adjusted operating income was $1.52 billion compared to $1.93 billion. Adjusted net income dropped to $1.11 billion from $1.46 billion.
For the first nine months of 2023, the company generated $12.36 billion in revenue compared to $12.57 billion in the same period in 2022. Adjusted operating income was $4.78 billion versus $4.95 billion. Adjusted net income in the first three quarters was $3.50 billion compared to $3.71 billion in the same timeframe last year.
Weaker consumer demand is largely responsible for the declines this year. Carload volumes slipped as people have cut back on discretionary spending due to the steep increase in interest rates in Canada and the United States. CN’s intermodal freight revenue dropped 23% over the first nine months compared to the same period last year. Part of the decline is due to strikes at the Vancouver port. There is concern that some shippers who had to change to American ports during the strike might not return to Vancouver.
As households are forced to renew fixed-rate mortgages at much higher interest rates, there could be a continued decline in spending on non-essential goods in the coming year.
On the positive side, grain and fertilizer transport revenue surged 24% in the first three quarters of the year. Automotive, coal, and metals and minerals transport revenues also increased. Forestry products and petroleum and chemicals cargo revenue declined slightly.
CNR stock
CN trades for less than $145 per share at the time of writing compared to $173 late last year.
The trend has largely followed the economic mood in the market, as rising interest rates have fuelled increased concerns about the risk of a deep recession.
Looking ahead
Economists expect the Canadian and U.S. economies to continue to slow down in 2024 as the full impact of the rate hikes by the central banks takes effect. There is a risk that the Bank of Canada and the United States Federal Reserve have pushed rates too high or will keep them elevated for too long and could trigger a deep economic downturn. If that turns out to be the case, demand for CN’s services would likely drop.
That being said, in the Q3 earnings report, CN said it is still targeting compounded annual diluted earnings per share (EPS) growth of 10-15% during the 2024 to 2026 timeframe as it expects to grow volumes at a faster pace than the anticipated growth in the economy. Management expects to achieve this by raising prices above the rate of rail inflation and improving overall efficiency in the company’s operations.
Based on this guidance, it appears CN anticipates an economic rebound over the next few years.
Dividends and share buybacks
CN has a long history of returning cash to shareholders through dividend increases and share buybacks. The board increased the dividend by 8% for 2023. The company’s compound annual dividend-growth rate since CN went public in the 1990s is well above 10%. At the time of writing, the stock provides a 2.2% dividend yield.
CN recently increased its share-buyback allocation under the current normal course issuer bid from $4 billion to $4.5 billion. The company can repurchase up to 32 million shares over the 12-month period ending January 31, 2024. Reducing the number of common shares means owners of the remaining shares get a bigger slice of the pie. It is a way for the company to boost earnings per share, which can lead to a higher share price. It also reduces the number of shares that receive dividends, so more free cash flow can, in theory, go to the remaining owners of the stock.
Is CN a buy today?
Near-term volatility should be expected until the market has a clear idea of when rate hikes will end and if the economy will see a soft landing. That being said, buying CN stock on big dips has historically proven to be a profitable move for patient investors. If management’s earnings outlook for 2024-2026 is correct, investors might want to start nibbling on CNR stock while it is out of favour.
