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Why is Canadian National’s Valuation Gap Narrowing against Peers?

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Canadian National’s valuation

Canadian National’s (CNI) strong operational focus and network geography have transformed it into an industry leader in operating efficiency. CNI operates faster trains than any other Class I railroads that deal with congestion along the US East Coast.

As long as fuel costs remain low, running faster and longer trains should help the Montreal-headquartered railway to improve operating margins and earnings.

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Forward PE multiple 

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 forward PE ratio is the same. This represents a no premium, no discount situation.

Historically, Canadian National has traded at a premium compared with its peer group. We consider its archrival Canadian Pacific (CP), Norfolk Southern (NSC), CSX Corp. (CSX), Kansas City Southern (KSU), Union Pacific (UNP), and Genesee and Wyoming (GWR) as its peers.

Investors looking for a pure play in US-specific rail stocks can invest in the Vanguard Dividend Appreciation ETF (VIG). All the US-originated Class I railroads make up the portfolio holdings of VIG.

Although CNI’s valuation gap has virtually closed against peers, it still trades at a 6.7% discount when compared with the S&P 500’s forward PE of 17.8x.

The above graph shows two important aspects:

  • The valuation of all major US railroads, along with CNI, has slipped from its highest levels in early January 2015.
  • Since February 2016, the railroads’ valuation has surged past than what it was five years before.

Valuation concerns

The slowdown in the Canadian and US economies, coupled with dull growth in manufacturing output in the US, weakened Canadian National’s (CNI) freight-hauling prospects going forward. The management has revised its original guidance issued in January 2016.

Canadian National now expects the strong Canadian dollar, along with sustained weakness in many commodity markets served by the company, to subdue its earnings going forward. This is evident from the company’s downward estimate of its earnings guidance issued earlier.

However, management believes that rail inflation pricing, along with various cost curtailment initiatives, should support the earnings growth. Plus, the current stock buyback program of $2.0 billion Canadian should also provide an impetus to the earnings going forward.

Canadian National’s (CNI) initiatives to augment its intermodal growth have already been priced in the stock. In addition, investors have also considered the prospective coal revenues debacle. We could see Canadian National’s stock price being adjusted for any automotive volumes headwinds going forward.

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