An expensive tank of diesel hurts more when filling it is part of how you earn a living. Transport companies can’t simply stop moving goods until fuel gets cheaper. They need customers willing to share the bill.
That makes pricing power especially valuable during a fuel shock. A business that can recover higher costs has a better chance of keeping its profits intact. For investors, that ability can be more useful than a large dividend from a company struggling to afford it.
Canadian diesel prices have become a prominent part of the inflation story. The attraction in rail is that fuel recovery is already built into many customer arrangements. The business has tools to respond before management needs to invent a new strategy.
Source: Getty Images
More revenue isn’t always more profit
Fuel surcharges add a charge linked to fuel prices on qualifying shipments. They help protect the railway over time, although the recovery can lag the cost and differ across contracts. A sudden jump can still make for a not-so-great quarter.
They also make the financial statements less intuitive. If a railway charges more to recover a larger diesel bill, revenue and expenses can rise together. The headline sales increase can overstate the improvement in the underlying business.
Imagine a shipment producing $100 of revenue and $60 of operating costs. Add $10 of fuel expense and a matching surcharge. Profit remains $40, but costs rise from 60% to roughly 64% of revenue. The cost percentage looks worse even though the dollars left haven’t changed.
A network customers need
Canadian National Railway (TSX: CNR) has another advantage beyond the surcharge. Its network connects important production centres, ports, and customers. Recreating those routes would require extraordinary spending, land access, and approvals.
For many long-distance shipments, rail also offers an efficient way to move large volumes. A customer still needs grain, chemicals, or other products delivered when diesel is expensive. Reliable service makes it easier for CN to keep that relationship and negotiate worthwhile prices.
CN’s second-quarter adjusted operating ratio was 62.2%, compared with 61.7% a year earlier. That means operating costs consumed a slightly larger share of revenue. Fuel recovery helps explain why the ratio needs to be read alongside the actual freight business.
The company also repurchased about 2.9 million shares for a total value of $454 million during the quarter. That’s roughly $157 a share on average for those past purchases, at writing. Repurchases can increase each remaining shareholder’s ownership, provided the price paid is sensible.
Into earnings
I like CN as a long-term holding built around an essential service. The dividend is part of the attraction, but a modest starting payment needs growing profits behind it. Buying solely for yield misses much of what makes the railway useful.
I’d build a position gradually. Fuel recovery can’t fix weak shipment volumes, expensive winter disruptions, or rising wages by itself. A recession could reduce the amount customers need moved, even if CN keeps a sound price on each shipment.
The share price deserves patience too. An excellent railway can still disappoint a buyer who pays for years of improvement in advance. I would keep the position manageable alongside Canadian stocks earning from different customers and industries.
Bottom line
CN’s pricing arrangements give it a practical response to expensive diesel. Its network gives customers a reason to keep using the service. Together, those strengths support a more appealing dividend-growth investment than the yield alone suggests. I’d own it for years of freight earnings, with the dividend providing a welcome payment while that business develops.
