Railroad Stocks on a Faster Track

06/09/2009 12:01 am EST

Focus: GLOBAL

Tom Slee

Retired- Financial Advisor, Money Manager, Gordon Pape Enterprises LTD

Bellwether Canadian carrier CN Railway is looking good, if not quite as good as Burlington Northern, writes Tom Slee in the Internet Wealth Builder.

Canadian National Railway (TSX: CNR, NYSE: CNI) is generally regarded as the major Canadian bellwether stock, so there was widespread relief when the company's first-quarter earnings beat expectations. Operating profit came in at 64 cents a share, compared to 62 cents in 2008 and a shade above the 61-cent consensus forecast. The numbers were nothing to write home about, but they could have been a lot worse. Rival Canadian Pacific (TSX: CP, NYSE: CP) reported a 31% dip in first-quarter earnings.

That, however, is just about the end of the good news. First-quarter revenues were down 4% year over year, and chief executive officer Hunter Harrison protected his bottom line by running fewer trains and cutting discretionary expenses. Earnings were also helped by a 41% drop in fuel costs.

[But] let's face it: The company lost momentum during the first quarter, and net cash flow fell 6% to $480 million. The all-important operating ratio (the percentage of revenues used to operate the system) deteriorated 1.2 percentage points to 74.1%. That is still the best in the industry (CP has an 87% operating ratio), but we tend to set the bar high for CN.

Looking ahead, everything hinges on shipping volumes, and right now all North American railways are feeling the pinch. Carload traffic is down 18% this year and, based on most economic forecasts, it's likely to remain flat into the third and fourth quarters. I think that CN is weathering the storm well and could earn $3.60 a share in 2009 followed by an increase to the $4.30 range next year. 

Of course, if the Canadian recession deepens or becomes more protracted, I may have to [lower] those projections. My more immediate concern is that the stock has strengthened recently and now has one of the highest multiples amongst the railroads [Shares closed at $43.90 in New York Monday, for a trailing  price/earnings ratio of 11.6—Editor.] Investors may be unwilling to pay much more for anticipated earnings growth in these difficult times. So while CN remains a Buy for long-term investors at current levels, Burlington Northern (NYSE: BNI) is my preferred choice in the industry.

BNI is performing better during the downturn than many analysts expected, and is well positioned to generate above-average revenue and earnings growth once the recovery gets under way. Its exposure to the long-haul coal, grain, and intermodal markets should pay off. All things considered, we could see earnings of about $5.60 a share in 2009, a decline from $6.33 a share last year, followed by a rebound to the $7.00 range in 2010. At the current price, the stock is not reflecting even this relatively cautious outlook. [Shares closed at $76.89 in New York Monday, up 6% since Mr. Slee's recommendation—Editor.]

Subscribe to Internet Wealth Builder here…

Related Articles on GLOBAL