Contents
Summary
- CNR released its Q3 results on October 23rd and reported quarterly revenue of $3.688B - the highest in its 99 year history.
- Net income was lower than in Q2 due to higher fuel prices, higher labour costs (increase in headcount and higher training costs for new employees), higher costs as a result of increased volumes of traffic and operating performance below 2017 levels, and the negative translation impact of a weaker Canadian dollar.
- CNR has staged an impressive turnaround over the last couple of quarters under new leadership. The true test, however, will come during the winter season (the harsher the weather the greater the challenge).
- Shares are currently fairly valued but current market weakness may put downward pressure on share price (view this as a positive).
NOTE: All figures are expressed in Canadian dollars.
Introduction
It is amazing how a company the size of Canadian National Railway Company (TSX: CNR) can turn around its fortunes in a relatively short timeframe when someone who truly understands the company and the industry takes the helm.
Earlier this year, the deterioration in CNR’s performance was so severe that it was at a very high risk of losing business to Canadian Pacific Railway Ltd. (TSX: CP); more on this matter can be found in my July 25th article.
During the height of all the negative press I decided to acquire another 400 shares for the FFJ Portfolio at $98.20/share thus bringing my total CNR exposure in the FFJ Portfolio to 1117 shares (currently 1127 due to reinvestment of dividends).
When I decided to acquire these additional shares I recalled the following famous Warren Buffett quote:
"The best thing that happens to us is when a great company gets into temporary trouble . . . We want to buy them when they're on the operating table."
In my opinion, CNR is a great company which was experiencing severe issues that could, with the right leadership, be corrected.
CNR announced in September that it believes beefed-up inventories of locomotives, hopper cars and extra staff will help to prevent a repeat of last winter's grain-shipping backlog which farmers said cost them millions of dollars in lost income. In fact, CNR announced it had ordered 60 additional locomotives from GE transportation; it had placed a 200 unit order in December 2017.
Fast forward to the present and CNR has just reported Q3 2018 results as at September 30th in which it has generated the highest quarterly revenue of its 99-year year history.
While some investors will view the pullback in CNR’s share price to the current ~$107.8 from a high of ~ $118 set in early October as a negative, I encourage long-term investors to view this retracement in CNR’s share price from a positive perspective.
Q3 2018 Financial Results
CNR’s Q3 2018 results released October 23, 2018 can be found here and its non-GAAP Measures commentary can be accessed here.
While CNR has generated record revenues it has also experienced an increase in higher fuel and labor costs. I do not feel there is a need to be concerned with the quarterly increase in costs reported below since these additional costs are necessary to make CNR a better rail company.
Source: CNR Q3 2018 Earnings Presentation – October 23, 2018
The following table provides a reconciliation of net cash provided by operating activities as reported to free cash flow for the 3 and 9 ended September 30, 2018 and 2017.
Source: CNR Q3 2018 Earnings Release – October 23, 2018 (page 8 of 51)
In my July 25th article I provided a high level snapshot of CNR’s Q1 and Q2 results which indicated that CNR’s performance had improved in one quarter; I once again provide the links to the two previous quarter’s earnings releases should you wish to compare the extent to which CNR’s results have improved.
CNR Q1 2018 Earnings Release – April 23, 2018
CNR Q2 2018 Earnings Release - July 24, 2018
2018 Financial Outlook
With 3 months remaining in the current fiscal year, management has reaffirmed its outlook previously communicated at the end of Q2.
Source: CNR Q3 2018 Earnings Presentation – October 23, 2018
Credit Ratings
There has been no change to CNR’s credit ratings subsequent to the July 25th article.
Moody’s rates CNR’s senior unsecured long-term debt A2 which is the middle tier of the ‘upper medium grade’ rating.
S&P Global rates CNR’s senior unsecured long-term debt A which is the middle tier of the ‘upper medium grade’ rating.
The A2 and A ratings are equivalent.
Neither agency has CNR’s credit ratings under review.
These attractive credit ratings confirm neither agency is of the opinion CNR will have any difficulty in servicing its obligations.
Valuation
In my January 29th article I noted that management had disclosed an adjusted diluted EPS target range of $5.25 - $5.40 (versus $4.99 in 2017) on the January 23rd investor conference call. Using the January 25, 2018 $97.02 closing stock price, I arrived at a forward adjusted diluted EPS ratio range of ~18 - ~18.5.
At the time of my July 25th article, CNR’s stock price was trading at ~$116.80. Using the revised adjusted diluted EPS range of $5.30 - $5.45 I arrived at a forward adjusted diluted EPS ratio range of ~21.4 - ~22.
On the recent Q3 conference call, management indicated it is still aiming to deliver adjusted diluted EPS in the range of $5.30 - $5.45. With CNR trading at ~$107.80 we now get a forward adjusted diluted EPS ratio range of ~19.78 - ~20.34; CNR’s 5 year average PE is ~19.5.
Dividend and Dividend Yield
CNR’s dividend history can be found here.
On October 23rd, CNR announced a new normal course issuer bid for the repurchase of shares for cancellation. The normal course issuer bid will occur starting on October 30, 2018, and ending no later than January 31, 2019 and will permit the repurchase of up to 5.5 million common shares which is equivalent to ~0.9% of the 611,354,197 common shares issued and outstanding not held by insiders on October 16, 2018; on the 16th, 730,422,928 CNR common shares were issued and outstanding.
The current normal course issuer bid announced in October 2017 for the purchase of up to 31 million common shares expires on October 29, 2018. As at the close of trading on October 22, 2018, CNR has repurchased 18,851,299 common shares at a weighted-average price of $103.83/share, excluding brokerage fees, returning $1.96B to shareholders. Purchases were made on the open market and will continue to be purchased under this normal course issuer bid until October 29, 2018.
In addition to announcing a new normal course issuer bid, the Board also approved a $0.455/share Q4 dividend. This dividend will be paid December 28, 2018 to shareholders of record as at the close of business on December 7, 2018.
On the basis of the current ~$107.70 share price, the dividend yield is ~1.68%.
Final Thoughts
Earlier this year when CNR was experiencing some challenges I viewed its shares as being a bargain which is why I acquired an additional 400 shares.
When I wrote my July 25th article, Mr. Market had already recognized that CNR was once again under the right leadership and that it had a game plan to fix the problems which had resulted in a strained relationship with various segments of its customer base (in particular the Canadian grain farmers). The share price at the time of that article had been bid up to the point where I viewed the shares to be somewhat overpriced.
CNR’s shares have since pulled back ~$10 from early October when they were trading at ~$117 – ~$118 and are now valued just a shade above their 5 year average.
I currently have a full position and do not intend to acquire additional shares other than through the automatic reinvestment of dividends. I wish, however, to add 1 or 2 additional rail companies to the FFJ Portfolio. My intent is to analyze and write about the most recent results and projections of other North American Class A rail companies.
I wish you much success on your journey to financial freedom.
Thanks for reading!
Note: I sincerely appreciate the time you took to read this article. Please send any feedback, corrections, or questions to [email protected].
Disclaimer: I have no knowledge of your individual circumstances and am not providing individualized advice or recommendations. I encourage you not to make any investment decision without conducting your own research and due diligence. You should also consult your financial advisor about your specific situation.
Disclosure: I am long CNR.
I wrote this article myself and it expresses my own opinions. I am not receiving compensation for it and have no business relationship with any company whose stock is mentioned in this article.
