Investors in Canadian National Railway (TSX:CNR) might be a bit stressed out these days, and it’s not hard to see why. Shares of CNR stock have been under pressure recently, to put it mildly. As of writing, shares are down about 12% year-to-date, and almost 20% in the last year alone.
So, does this mean investors can get in on an opportunity, or should they beware of this dropping railway stock? Let’s dig into what’s going on with CNR stock, and get into the bull and bear options.
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What happened
CNR stock has had a few issues that have put it under the investor microscope, so let’s get into them here. First, slowing revenue growth and volumes have seen quarterly revenue down 1.3% year over year. For a railway, these small declines in volumes or pricing can dent growth and therefore investor sentiment. Add in the macroeconomic sensitivity – with rail freight volumes tracking industrial activity, energy production, auto manufacturing, and intermodal trade – and softening can seriously hurt the stock.
What’s more, CNR stock has high leverage and low cash buffers. Its total debt sits at $20.9 billion at writing, with its debt-to-equity (D/E) ratio near 97%. This has raised concerns about financial flexibility, especially if interest rates stay higher or if cash flow weakens. And with cash on hand at $217 million, this is relatively low compared to its debt.
Finally, investors have been fearful about the future. CNR stock is capital-intensive, spending heavily on network maintenance and expansion. So if capital expenditures or investment timing increase, then free cash flow (FCF) can be volatile. Taken together, it’s a stock under stress.
Any hope?
Now that we’ve gone over the bear case, is there any hope for the once-great stock? In fact, there are a few points to consider. For one, CNR stock has demonstrated strong profitability and returns. Its profit margin remains at 26.6% and operating margin at 41%, with a return on equity (ROE) at 22.3%. These are actually high for a capital-intensive business, showing it remains an efficient operator with pricing power.
What’s more, CNR stock has solid cash flow generation. Its operating cash flow came to $6.7 billion for the last year, with leveraged free cash flow at $2.3 billion. This shows it can generate significant cash that can fund capital expenditures, dividends, debt paydowns and even buybacks.
What’s more, it’s a durable franchise with a solid moat. CNR stock is a North American Class I railroad part of a duopoly, and therefore has very little competition in the sector. These high barriers to entry and extensive network are nothing but a benefit. Better still? It still offers a 2.8% dividend yield with a 48% payout ratio at writing.
How to decide
There are a few items to consider – first, whether CNR stock is valuable or not. The company trades at a trailing price-to-earnings (P/E) of 17.5 and forward PE at 15.1. This shows the stock is looking more and more valuable compared to recent history. However, its price-to-book (P/B) of 3.8 shows investors still price in a premium over book value.
Interested investors will likely be watching a few things then. For instance, volume and revenue need to trend upwards, so watching quarterly carloads, intermodal volumes, and revenue per ton/mile or revenue tonnage will be important. Guidance will hopefully come up, and free cash flow must be able to sustain dividends and reduce debt. Furthermore, investors will need to be sure it doesn’t lag behind peers in both earnings and share price.
Foolish takeaway
There are thus a few options here. If you’re interested, dollar-cost averaging can be a great way to get in on value, while equalling out your investment to reduce timing risk. You could also wait for a few quarters to see if there are improvements.
Yet overall, CNR stock is far from a broken company. It still generates strong margins, cash flow, and a defensible network. The pullback has actually improved its valuation, making now a possibly attractive entry point. However, near-term risk comes from macro sensitivity. So investors will need to manage their own risk tolerance before considering an investment in this railway stock.
