Canadian National Railway (TSX:CNR) is a barometer for the Canadian economy. Moving a wide range of products across the country, it captures the movements of goods and tells a story. And the story it has told in the last year is one of an economic slowdown. After a decline of 10% in the last year, is CNR stock a good buy candidate?
The Canadian economy
As we know, the Canadian economy has been hit with inflation and soaring interest rates. Today, inflation remains above the target range and interest rates are much higher than a few years ago. This changes everything. Consumers are more cautious with their spending, everything is more expensive, and general economic activity is slowing.
So where does that leave CN rail stock?
The Canadian railways transport more than $250 billion of goods annually from a diversified list of sectors. Natural resources, crude oil, manufactured products, and consumer goods all find their way to our homes through railways. So Canadian National Railway is the backbone of our economy. When the economy suffers, so will Canadian National Railway.
Not surprisingly, the current economic troubles are affecting the company significantly. Its latest earnings report shows this very clearly. For example, third quarter EPS came in 21% lower than a year ago. Also, revenue declined 12% and gross margins were hit.
Yet, the company remains a well managed one with many qualities that make it a good stock to own for the long term. For example, Canadian National has a wide economic moat with plenty of barriers to entry, keeping potential competitors out of its territory. Also, Canadian National has an industry leading operating ratio of 62%, which is defined as operating expenses divided by revenue.
New opportunities to drive growth
Beyond Canadian National’s well-entrenched operating strengths, there are new opportunities to create additional growth and scale. This exists most obviously in the Prince Rupert Port. This port is ideally situated to reach Asian markets, as it’s the shortest and fastest route on the transpacific. Also, it can accommodate the largest vessels in shipping and it’s ice-free year-round.
Altagas Ltd.’s (TSX:ALA) Ridley Island Propane Export Terminal is situated near the Prince Rupert port and is seeing tremendous growth in its exports to Asia. Canadian National Railway has exclusive access to the Port of Prince Rupert. As such, Canadian National has entered into a renewed and expanded five-year transportation agreement with Altagas. The expansion of the existing Ridley Island Road Rail Utility Corridor is included in this project. This will facilitate longer trains having direct access to the site. In the end, this will help drive greater future volumes for Canadian National.
Long-term guidance on CNR stock stands
According to CN Rail’s management, their long-term guidance of 10% to 15% EPS growth still stands. In 2023, flat to slightly lower EPS is expected but in the long run, the company expects to revert back to higher growth.
The company’s latest update had management sharing that they believe the worse is behind them. The railroad is currently seeing sequential demand improvements, with October posting a 10% sequential improvement, and November tracking even better than that so far.
The bottom line
It’s hard for me to be really bullish on CN Rail stock at this time for two main reasons. Firstly, the railroad business, like the economy, is cyclical. Today, we are coming off of a very strong economic time period and heading into slowing growth. This does not bode well for companies like Canadian National Railway. Secondly, I don’t believe that this downturn will be as short-lived as we hope. Thus, I think there’s still more downside for CNR stock.
