In our most recent missive about Canadian National Railway Company (NYSE:CNI), we spent some time talking about the company's partnership with JB Hunt. We consider this to be significant because partnerships of this sort get to the heart of what customers want. Customers aren't interested in a "railroad service" so much as they are interested in a "supply chain service." In this piece we'll write about port authority partnerships and we'll focus on some relevant updates. We strongly believe that the future growth in railroading comes from the realization that customers aren't buying a rail service. In future, we'll use this capacity to service the "last mile" as a way to judge the relative merit of each of the Class I railroads.
As our readers know, Canadian National Railway is unique among the Class I railroads in that they service three coasts. There are some very positive things happening at ports on all three coasts that should benefit Canadian National enormously into 2017.
Since most container traffic comes to North America across the Pacific, we'll start at the West Coast. The port of Prince Rupert has seen the fastest growth of container traffic of any North American port over the past seven years and they plan to expand the terminal by another 500,000 TEUs by 2017. Having the capacity to take more traffic through the port in 2017 and beyond is obviously significant for CN.
Some virtual ink has been spilt suggesting that the expansion of the Panama Canal will be troublesome for West Coast ports. Fortunately for Canadian National, any trouble in that regard will be ameliorated somewhat by what's happening in Mobile, Alabama. Canadian National recently announced a memorandum of understanding with the Alabama State Port Authority and operator APM terminals. The fact that the port of Mobile is expanding its intermodal capacity by ~90% and it is moving beyond being an almost pure coal port is a positive in our view. The port is geographically well positioned relatively near the US heartland and will likely benefit from an expanded Panama Canal.
Canadian National also serves the port of Halifax, which has seen volumes drop, but a turnaround may be in sight for two reasons. First, larger ships will be passing through the port. Second, the port is a great alternative to more congested East Coast ports. Of the three developments, we're less optimistic about this one, but as trade grows, so too does the work required of various ports.
The Operating Ratio
Much has been made of the fact that CN has the lowest operating ratio in the industry. The fact that much of this is a function of a $.75 Canadian dollar highlights two issues. First, at some point the Canadian petro-currency may return to par again which would be troublesome for CN Rail. Second, when compared to the other Canadian operator, the relatively better operating ratio at CN reflects the currency diversification you get at CN. A much greater percentage of Canadian Pacific's costs are in Canadian dollars.
What You Pay Vs. What You Get
Our own research suggests that dividend yields are less relevant to the future performance of railroads than the (relative) valuation. It's with this in mind that we should rank the Class Is. In regard to its valuation, we'd say that Canadian National is almost exactly average. It's trading at a PE of ~18.87, as compared to the mean PE of 18.29. The dividend yield is a bit on the soft side. The yield at Canadian National is 1.62% against the average yield of ~1.97% amongst its Class I peers.
Holding all else constant, we consider Union Pacific to be the superior railroad. Things aren't constant, though. From the point of view of our Canadian readers, the risks of losing capital as the currencies approach par again is far greater than the rewards of buying a railroad with a PE of 15 versus one of 18.87. So, for our American readers, we consider Union Pacific to be the way to go. For Canadians, there's no better Class I railroad than Canadian National.
Current as of November 21, 2015
We continue to be impressed by Canadian National Railroad. The company is a truly international railroad that is capable of servicing the large American heartland via three coasts. We are impressed by the various efficiency statistics around train velocity, operating ratio and so on. Perhaps of greatest importance, though, is the fact that management seems to realize that their customers are more interested in a supply chain solution than a railroad solution. The partnership with JB Hunt (and likely others) is an expression of this. The fact that the company benefits from what's happening at three of the ports it services suggests a promise of a very profitable 2016 and beyond. For Canadian investors not willing to tolerate the currency risk of buying Union Pacific, we feel Canadian National Railway is the superior choice.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.