Is Canadian National Railway a Good Buy?

Source: Thinkstock

Source: Thinkstock

The railroad industry has been one of the best places to be over the past several years. All of the major North American railroads have seen substantial triple digit gains over the past decade as well as back to the turn of the century.  Of the major North American railroad companies, the best performer during the 21st century has been, surprisingly, Canadian National Railway (NYSE:CNI) — Canada’s largest railroad company and the second largest publicly traded North American railroad only to Union Pacific (NYSE:UNP).

Canadian National Railway has been a beneficiary both of the bull market in rail transport companies and of the bull market in commodities. Let us see why.

As I said, the rail industry has been one of the best places to be over the past several years. There are two primary reasons for this. The first is that the railroad industry is a de facto oligopoly with an enormous moat. In all, there are just seven companies that dominate North American rail:

While there are some places on the continent where these companies have property clustered together such as in the northern Midwestern United States, for the most part any given region is serviced by just one or two, sometimes three of these companies. Canadian National, perhaps more so than its peers, benefits from this insofar as it has a lot of unrivaled track in northern Canada. It is also only one of two that has track that spans the entire continent from the Pacific Ocean to the Atlantic Ocean. It follows that if something in northern North America is going to be shipped by rail, then Canadian National  has a high probability of shipping it.

Second, with rising oil prices, companies have been looking for inexpensive ways to ship bulk goods. Railroads do just that. A train is very fuel efficient relative to a truck, and it is like several hundred trucks that have just one driver. The fact that railroad companies save on fuel and labor costs makes them especially profitable.

Canadian National is a beneficiary of higher oil prices in another respect. With rising oil prices, and with rising commodity prices more generally, Canada is rich with resources and has been producing more than it consumes, meaning that it has to be exported. Canadian National has been a beneficiary of this, as is evidenced by the fact that over the past several years the company’s business has seen its revenues from commodity shipments become a larger part of its overall portfolio. Canadian National has seen a significant increase in its shipments of metals, oil, potash, and even coal. This last point is significant given that American railroad companies Norfolk Southern and CSX Corp. have been hurt by declining coal shipments.

Given all of these points, Canadian National seems like an ideal investment. Unfortunately, my sentiment is not a unique one and I think that the shares are somewhat expensive at 20-times earnings, especially when you can buy Norfolk Southern and CSX Corp. at a 20 percent discount. Furthermore, while Canadian National showed profit growth last year, this was in Canadian Dollar terms. If we correct this for the weakness we have seen in the Canadian Dollar, then Canadian National’s earnings have been more or less flat over the past year.

Therefore, Canadian National shares need to pull back. Given the outstanding quality of the company’s business longer term, this pull back doesn’t have to be extreme. But I do think investors should wait for a 15 percent correction or so before backing up the truck. Ultimately, I think that in the long term, Canadian National may be the best railroad to own, and if there is a market correction in the coming weeks or months this is one stock that I will be buying.

Disclosure: Ben is long CSX shares.

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