July 9, 2010
We are initiating coverage on Canadian National Railway (CNI) with a Neutral recommendation and a Zacks #3 (Hold) Rank. We believe increased traffic, solid execution, significant increase in industrial production, ongoing inventory replenishment and a sharp rebound in many of the company’s end markets will fuel growth going forward, due to a sustainable improvement in the economy.
Canadian National consistently leads the Class I railroads relative to several key financial metrics. The company has the industry best operating ratio, free cash generation, return on equity and return on invested capital. The company expects solid double-digit earnings growth for 2010, with carload growth in the low double digits and pricing improvement of about 3.5%. It expects a sustainable operating ratio in the mid-60s over the next few years, given a stronger volume growth at low cost with productivity initiatives such as improving system velocity and fuel efficiency.
Canadian National is expanding its business and investing in certain capital programs, which will allow it to operate efficiently and effectively. The company is making improvements in railway tracks and network in order to restore profitability. It is continuously looking for productivity initiatives to reduce costs and is investing to improve locomotive fuel efficiency.
Canadian National enjoys a strong competitive position within the North American Class I railroad industry. However, it faces significant competition with Canadian Pacific Railway (CP), which is based in Canada and provides services in the same regions that are covered by Canadian National. The company is prone to volatility in fuel prices and operates in a capital intensive industry. The major threat to the company is its unionized workforce. Majority of the company’s Canadian and U.S. employees represent union members. Disputes with the employees could potentially result in strikes, work stoppages, slowdowns and loss of business, thereby impacting the profitability of the company. Currency exchange rate is another threat to the company.
Canadian National pays higher return to its shareholders via share buyback and increased dividend. At the beginning of 2010, the company increased its quarterly dividend by 7% to C$0.27 from C$0.2525 and currently has repurchase authorization of 15 million shares through the end of December 2010. Annualized dividend of the company totals C$1.08 ($1.04), which represents dividend yield of 1.8%. However, this dividend yield is lower than its railroads peers — Canadian Pacific, Union Pacific Corporation (UNP) and Norfolk Southern Corp. (NSC). These companies have dividend yields of 1.9%, 2.0% and 2.7%, respectively.
Our Zacks Consensus Estimate for the second quarter is 98 cents compared with earnings of 69 cents per share in the year-ago quarter. If the company meets the Zacks Consensus Estimate, it would lead to a substantial gain of 42% year over year. With respect to earnings surprises, the company’s fairly good track record is expected to persist in the coming quarters. Canadian National produced an impressive average earnings surprise of 3.9% over the last four quarters, which suggest that it beat the Zacks Consensus Estimate by that amount over the last year. The company surpassed Zacks Consensus Estimate by 6.7% in the most recent quarter.
Canadian National Railway is engaged in the rail and related transportation business. The company spans Canada and mid-America from the Atlantic and Pacific oceans to the Gulf of Mexico, serving the ports of Vancouver, Prince Rupert, British Columbia, Montreal, Halifax, New Orleans, Alabama, and the cities of Toronto, Buffalo, Chicago, Detroit, Duluth, Minnesota/Superior, Wisconsin, Green Bay, Wisconsin, Minneapolis/St. Paul, Memphis, St. Louis and Jackson, Mississippi, with connections to all points in North America. It has the lowest operating ratio among Class I railroads. On January 31, 2009, Canadian National completed the acquisition of principal lines of the Elgin, Joliet and Eastern Railway Company.
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