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October 29, 2020

Can CN Rail (TSE:CNR) Keep up It’s Dividend Growth?

Disclaimer: The writer of this article may have positions in the securities mentioned in this article. The fact they hold positions in securities has had no impact on the production of this article

By Dylan Callaghan

October 29, 2020

CN Rail dividend

 

If I was tasked with making overall economic predictions moving forward based on a single stock industry, it would be a no brainer for me to choose railways.

Why? Well, they’re often the bellwether of the Canadian economy, primarily because railways still ship the majority of goods across the country and to the United States.

When shipments slow or stall, it is a sign that the economy will soon follow.

We have two primary railways here in Canada, both of which form a duopoly and both are excellent Canadian dividend stocks.

In this article I’m going to highlight Canadian National Railway (TSE:CNR), its dividend growth and safety, and provide a bit of an economic outlook for the stock moving forward.

 

What is Canadian National Railway (TSE:CNR)?

Canadian National Railway is the only transcontinental railway in North America, and the company currently has 19,600 miles of track that spans Canada and Mid-America.

CN Rail’s track connects three different coasts together, the Atlantic, Pacific, and Gulf of Mexico.

In 2019, the company delivered nearly 6 million carloads and generated roughly $14 billion in revenue. At the time of writing, the company is Canada’s largest railroad company and one of the largest stocks in the country with a market cap of $95.7 billion.

In terms of revenue allocation, the company attributed the following:

  • 25% to intermodal containers
  • 21% to petroleum and chemicals
  • 16% to grain and fertilizers
  • 12% to forest products
  • 11% to metals and mining
  • 6% to automotive shipments
  • 4% to coal
  • 5% to “other” forms of revenue generation

As we can see, the delivery of petroleum and chemicals still makes up a significant portion of the company’s revenue, highlighted by the fact that rail remains one of the most popular methods of transporting oil and petrochemicals.

So, we know the company is the largest railroad in the country, and is critical to the overall supply chain and Canada’s exports/imports. But, how safe is the dividend?

 

Lets have a look at CN Rail’s dividend

Canadian National Railway is a blue-chip dividend stock, however it does get scrutinized by Canadian investors for its small yield of around 1.67%.

However, these investors simply aren’t looking hard enough. And I’ll get to why in a bit.

CN Rail has a 24 year dividend growth streak, and has raised the dividend by 16.54% on an annual basis over the last 5 years. At this pace, CN Rail is set to double its dividend every 6 years.

 

TSE:CNR Dividend Yield

Market Cap: $98.17 billion
Forward P/E: 25.82
Yield: 1.67%
Dividend Growth Streak: 24 years
Payout Ratio (Earnings): 44.83%
Payout Ratio (Free Cash Flows): Premium Members Only
Payout Ratio (Operating Cash Flows): Premium Members Only
1 Yr Div Growth Rate: 18.13%
5 Yr Div Growth Rate: Premium Members Only
Stocktrades Growth Score: Premium Members Only
Stocktrades Dividend Safety Score: Premium Members Only

 

The dividend in terms of yield has remained relatively stable, we can see short term spikes from the mid 1.60% range periodically, with the dividend spiking to 2.2% during the COVID-19 pandemic. But as I’ve mentioned in previous articles, with a fast growing dividend like CN Rail’s, we want to see it’s yield remain relatively stable.

That means its stock price is going up, and CN Rail’s certainly has been. But more on that later.

The company has been growing earnings by 2.5% and sales by 1.7% over the last 5 years, so growth has definitely stalled. Most investors look to this to say that this rate of dividend growth may be unsustainable.

How can they continue to do so with limited earnings growth?

And while the company does still have a lot of room to grow the current dividend, I think a sign of slowing growth may be ahead. The answer lies within the company’s payout ratios.

 

TSE:CNR Payout Ratios

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Over the last 5 years, Canadian National Railway has hovered in the high 20% to low 30% in terms of payout ratios when looking at earnings. We can see that this payout ratio has been slowly increasing over the last couple years, and has spiked due to COVID-19. Payouts on a free cash flow basis are increasing as well.

Don’t get me wrong, this dividend is safe. In fact, I expect CN Rail to keep growing it for the foreseeable future.

Just understand that the mid to high teens in terms of annual growth may be in the rear view mirror in the next 5 years as we enter a recession and inevitable economic downturn due to COVID-19.

But investors of CN Rail not only get a growing dividend, they also get a stock that is providing excellent capital appreciation.

 

CN Rail stock is one of the fastest growing blue-chips around

I may sound like a broken record when I say this, but I really like to see a company with fast dividend growth, yet a maintained or slowly escalating dividend yield.

Why? Well, that means its share price is going up, and CN Rail’s has been at a rapid pace.

 

TSE:CNR Overall Performance

 

Since 2007, CN Rail has returned on a dividend adjusted basis 438.7% to shareholders. Now although this isn’t as high as the 561% by competitor Canadian Pacific Railway (TSE:CP), it’s still one of the fastest growing blue-chip stocks in Canada.

The company has been able to consistently generate free cash flows over this time period, and has done so to the tune of $2 billion dollars as of late 2020, even in the midst of a pandemic and the rail blockades earlier in the year.

The company is reporting a v-shaped recovery in terms of shipments, which is a good sign. It’s also reporting that there has been a significant shift in the business mix, with commodities like grain reporting record exports and lumber surging due to the home renovation activities going on in 2020.

 

TSE:CNR Price to Earnings

Be aware however, that on a price to earnings basis CN Rail hasn’t been nearly this expensive over the last half decade. You’re paying around 28.27 times earnings, whereas the company typically trades in the 18.9 range. This is a 49% premium to its historical trailing price to earnings, and the premium that CN Rail is trading at right now can’t be ignored.

Why the lucrative valuation, especially for a company that is predicted to see 1-2% top line growth in 2021?

My best guess would be that investors are flocking to defensive, blue-chip stocks in times of uncertainty. Financials are typically the first they shift to, however in this ultra low interest rate environment, industrials like railways are likely next. Another industry that we find investors looking for defensive plays within during times of instability, is grocers, like Canada’s Metro (TSE:MRU).

CN Rail has posted great dividend growth, great capital appreciation and I am a firm believer that a Canadian railway company should be part of every Canadian’s portfolio. However, it may be wise to wait for a dip if possible.

If you’re looking for an alternate, less expensive option, CP Rail is only trading  at a 30% premium to its trailing 12 month earnings. But there’s no questioning right now that Canada’s railways are expensive.

 

 

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Dylan Callaghan


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