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CNI’s Valuation Premium: Strong Operational Focus

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Mar. 3 2016, Updated 3:06 p.m. ET

Canadian National’s valuation premium

Canadian National’s (CNI) management’s strong operational focus and network geography have helped position it as an industry leader. CNI operates faster trains than any other Class I railroads, which deal with congestion along the US East Coast. Although faster railroads consume more fuel, in the current era of low fuel costs, it is a blessing in disguise.

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Forward price-to-earnings ratio

The price-to-earnings (or PE) ratio determines how many dollars the Market is paying for every dollar of expected earnings in the next 12 months per share on the stock. Canadian National’s current forward PE ratio is 16.6x while the peer group’s ratio is 14.9x. This represents a premium of 11.4%. However, when compared with the S&P 500’s forward PE of 21.1x, CNI’s forward PE is trading at a discount of 27.1%.

Looking at the graph, you will notice that in the last year, the valuation of Class I railroads have come down from its highest levels in the last five years. The slowdown in the Canadian and US economies, coupled with dull growth in manufacturing output in the US, shook the railroads’ freight-hauling prospects.

Higher revenue and earnings and growth

CNI’s revenues are expected to grow at 3.9% in 2016 against the expected average revenue growth of -1.9% for the peer group. The company’s operating margins improved at a five-year CAGR (compound annual growth rate) of 12% through 2015. Productivity gains and core pricing improvement are expected to offset the volume decline in the next four quarters.

While Norfolk Southern’s (NSC) revenues for fiscal 2016 are expected to fall by 3.8%, its competitor CSX Corporation’s (CSX) revenues may go down by 5.1%. As the major western operator, Union Pacific’s (UNP) revenues are forecasted to fall by 4.1%. CNI’s main rival, Canadian Pacific (CP), has revenues that are projected to rise by 1.5%. The smallest Class I railroad, Kansas City Southern (KSU), and the United States’ largest short-line operator, Genesee and Wyoming, are are expected to see in revenues in fiscal 2016.

If you are looking to invest in rail stocks, then the iShares US Industrials ETF (IYJ) holds 5.44% in major US-based railroads.

CNI’s diluted EPS grew by 16% in 2015. Its EPS in 2016 may grow at 5.5% based on consensus, which is in line with management’s outlook for mid-single digit growth. Plus, the $2.0 billion Canadian share repurchase program should also fuel its EPS growth in the coming times.

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