Railway stocks are among the widest-moat companies on the continent. Even though they’re sensitive to economic fluctuations, the top rail plays tend to be fantastic bets, regardless of the environment, due to their ability to weather storms and re-position themselves for the next phase of the bull run. Here in Canada, we have two impressive rail companies to choose from. While it may make sense to go with both over the long run, I think one play is markedly better for investors seeking deeper value.
As rate cuts start flowing in while the Canadian economy looks to improve after a tough few quarters, it makes sense to consider some of the top rail plays right here while they’re trading at relatively depressed multiples. Without further ado, let’s check out shares of CN Rail (TSX:CNR) and CP Rail (TSX:CP), now known as Canadian Pacific Kansas City (CPKC), following its merger with Kansas City Southern.
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CN Rail
CN Rail stock is currently sitting down more than 15% from its highs, thanks partly to a few less-than-ideal quarters. On the growth front, CN Rail doesn’t quite stack up to CPKC. However, there are numerous ways that CN can jolt its earnings growth profile.
First, CN Rail has room to expand its operating ratio (OR). In the past, CN has been one of the most efficiently run railways. Though it may have lost its way, I think it’s just a matter of time before OR-driving efforts start paying big dividends.
Second, CN Rail may be hungry for a massive rail deal south of the border. As you may know, CN Rail went into a bit of a bidding war with CPKC a while back. While CP walked away with the prize, I noted that the price paid for Kansas City Southern’s assets made little sense.
With plenty of dry powder, CN has options to pursue rail deals at a far better price. Given the regulatory environment, it may be tough to strike a deal south of the border promptly. Regardless, the option to further expand the network has me incredibly bullish on the firm’s next 10 years.
At 18 times trailing price-to-earnings (P/E), I view CNR stock as severely undervalued after its latest correction. The 2.2%-yielding dividend is also subject to above-average growth as CN finds new ways to jolt cash flows.
CP Rail
CP Rail stock may be a faster grower than CN, but its shares are already priced with that in mind. Arguably, I think CP has too much expectation baked in at current valuations. At $106 and change per share, CP stock trades at a whopping 28.5 times trailing P/E, making it way more expensive than its Canadian rival CN.
Even after the recent 14% pullback off highs, I view CP as overvalued and vulnerable to an even larger decline, perhaps below $90 per share. The company may be enjoying meaningful synergies from its Kansas City Southern deal of late, even as it wanders through a rail strike. Regardless, I don’t think going for CP stock at such a massive premium to CN makes any sense.
Also, the 0.7% dividend yield, while growthy, isn’t nearly as attractive as CN’s right now. Sometimes, it makes more sense to go with the value play than the more exciting growth-oriented one.
Bottom line
CN Rail is the far better pick right now. The valuation gap (18 times P/E for CN vs. 28.5 times for CP) between CN and CP is the widest I’ve seen it in recent years. Is the relative premium warranted? I definitely do not think so. I’d look for CN to outperform CP by a potentially wide margin over the next 12 to 18 months.
Though CP may be growthier and performing better lately, too many seem to be sleeping on CN. The company has ground to make up, but at today’s depressed multiples, it seems like few believe the firm can get back on the high track.
