Dividend Analysis of Canadian National Railway Company

A Reader has requested have a look at Canadian National Railway Company (CNI) which trades on the TSE under the symbol CNR. With Warren Buffett himself investing in rail transportation (Burlington Northern Santa Fe Corp), could this be our Canadian play?

Let’s have a look.

Company Profile:

From the 2006 Annual Report

Operates the largest rail network in Canada and the only transcontinental network in North America. The company operates in eight Canadian provinces and 16 U.S. states.

Market capitalization is $29.4B.

Company Fundamentals:

Starting with return on invested capital, I see a very nice uptrend over the last 5 years. From an ROIC of 4.9% back in 2002 to last year’s ROIC of 13.7%. The 5 year average ROIC is 9.9%.

Return on equity had been very consistent for the first 7 years in the 12% range. The last 3 years have seen the ROE jump to 17%. The 10 year average ROE is 13.45% while the 5 year average ROE increases to 14.91%.

The equity growth rate has been amazingly consistent. The 9 year rate is 11.62%. The 5 year rate increases to 13.61%. Last year’s equity growth rate comes back to 11.28%.

Earnings per share growth rate has trended upwards. The 9 year rate is 16.89%. The 5 year rate shoots up to 24.2%. The 3 year rate further increases to 37.24% and last year’s EPS growth rate drops back to 22.74%. Some of these great numbers over the last few years can be attributed to the EPS growth rate in 2004 which was 80.52%!

Sales growth rates have been steady and consistent as well. The 9 year rate is 6.55%. The 5 year rate is 6.4%. And last year’s rate comes in at 6.57%.

These fundamentals look good over the 10 year period. Definitely higher than I would have expected for such a ‘non sexy’ industry such as the railway.

Dividend Fundamentals:

Current dividend yield is 1.47%. This is definitely below the dividend yield available from the S&P/TSX Composite Index of 2.46%.

But the dividend growth definitely makes up for that below average yield. The 9 year dividend growth rate is a whopping 16.22%. The 5 year rate climbs to 20.08%. The 3 year rate further climbs to 25.29% and last year’s dividend growth rate was 30%! These are amazing dividend increases. Once again, not what I would have expected from this industry.

And to further sweeten the deal, the dividend payout ratio is very low. Back in 1997, the dividend payout ratio was 18.96%. Last year, the dividend payout ratio increased all the way to 19.12%. Although it has fluctuated over the 10 year period, that is incredibly consistent.

Cash flow growth rates have been growing very nicely as well. The 9 year rate is 16.28%. The 5 year rate comes in at 19.6%. And last year’s cash flow growth rate was 18.31%.

These dividend fundamentals look great - especially the historical dividend growth rates! This stock definitely deserves a spot in our portfolio of superior dividend yielding stocks.

Valuation Models:

Let’s calculate a fair price to pay for this stock using our 3 valuation methods.

Starting with the average high dividend yield model, I will use the historical yields to determine a model price. The 10 year average high dividend yield is 1.7%. The 5 year average high dividend yield is 1.54%. I typically prefer to use the 5 year average as it is more indicative of current interest rates. So, if I demand a yield of 1.54%, then the model price works out to $54.55. At the current price of $57.22, Mr. Market is demanding a small premium of 4.9%.

Benjamin Graham would not be as generous. Calculating the Graham number, I come up with $38.41 which implies a premium of 48.97%. Using my modified Graham number, the model price works out to $44.35 and a smaller premium of 29%.

For my discounted present value method, I used the following inputs:

• future EPS growth rate of 11.62% (This was determined from the 9 year equity growth rate. However, it is conservative compared to analysts’ forecast of 14.9%.)
• future PE of 15.08 (This is the 10 year average PE number and is lower than the current PE of 16.73.)
• dividend yield of 1.54% (the 5 year average high dividend yield.)
• future dividend growth rate of 20.08% (The 5 year dividend growth rate. This might be a bit on the aggressive side.)

With this information, my model price works out to $54.68. That is almost the exact same price as determined by the average high dividend yield model ($54.55).

Here is my dividend analysis of CNR.

Here is the 1 year stock price chart:

There have been many opportunities to buy this stock below the model price of $54.55.

Conclusion:

Well, I must admit that this analysis did surprise me a bit. I was not expecting a railway stock to deliver such excellent dividend growth. All the fundamentals look good and Warren Buffett seems to agree that railways are a good investment. I would definitely add this stock to our portfolio of superior dividend yielding stocks.

Full Disclosure: I do not own shares in CNR although that may change if there is a pullback in the next little while!

Comments

[Tyguy:]

how do you (or the street for that matter) typically look at the asset values of such companies (i.e. rolling stock, land, buildings etc)?

I was doing some rough calcs this morning and at the beginning of the year you could buy CN shares for approx the value of the land and buildings (just to be conservative I assume rolling stock is worth zero in liquidation) they hold net of debt (inc cap lease). Maybe the stock never got that cheap...but the margin of safety, at first glance, would appear to be pretty high at levels in the 30s.

My only other thought with respect to the land is would it really be worth anything in the hands of another company outside the rail industry?. I know for a fact some of these Co's own big chunks of land in interesting spots that true jems. Example being large pieces of land (and islands) in the Muskoka Ontario cottage district (playground of the rich north of Toronto).

Anyways one to add to the list in case it pulls back indeed. Would also point out a pretty sound pension position on the plus side but ownership restrictions which lowers probabilities for those taking takout mults and values into consideration.

Nov 04 03:24 PM