(The following story by Scott Deveau appeared on the Financial Post website on April 23, 2009.)
OTTAWA — Canadian National Railway Co. (CNR/TSX) has once again proven why the Street considers it to be the best-in-class North American railway, and why it’s preferred over its smaller domestic rival, Canadian Pacific Railway Ltd. (CP/TSX).
CN was the only Class-1 railway to buck a drastic drop in demand and report earnings growth during the first quarter of the year through improved efficiency that was aided by lower fuel costs.
While most analysts expect CN’s earnings to remain under pressure throughout the economic downturn, they continue to be upbeat about the long-term potential of the country’s largest railway.
“We believe CN is well-positioned to weather the downturn through continued pricing gains, strong operational execution, and foreign exchange tailwinds in the near term,” David Newman, National Bank Financial analyst, said in a note to clients.
“CN is likely to lead out of the recession.”
Mr. Newman has an “outperform” rating and $57 price target on the stock – about 12% above where it closed Thursday ($50.87, up 96¢). He has a “sector perform” on CP and a $44 price target, a less than 4% protected return from Thursday’s close.
Driving his confidence in CN is its management’s proven ability to run the leanest operations amongst top-tier rails. CN’s operating ratio – an important gauge of profitability that measures operating costs as a percentage of revenue – was 74.1% during the first quarter, up 1.2 percentage points compared with last year.
However, excluding costs associated with integrating its recently acquired Elgin, Joliet, & Eastern Railway, it would have fallen to 71.7%, management noted.
The lower the number the better, and the industry average for the quarter was 79.7%. CP’s operating ratio in the first three months of the year was 87%, up from 82.4% for the quarter in 2008, after it failed to adequately curtail its operations in step with declining demand.
Walter Spracklin, RBC Capital Markets analyst, contends investors should keep CN as a core holding, but with its shares trading within spitting distance of his $52 price target, he lowered his rating to a “sector perform” this week.
He also recommend switching to Norfolk Southern Corp. (NSC/NYSE), which is also a low-cost, high-quality rail that is trading at a discount to its peers, he said.
“Further, [Norfolk] has a strong track record of free cash flow growth and is viewed as the best dividend-grower in the group,” Mr. Spracklin said in a note.
But Fadi Chamoun, UBS analyst, said he thinks the premium CN trades at is “warranted.” He has a “buy” rating the stock and a $57 price target, but said he expects the company’s earnings to be “flat to modestly up” in 2009 in the absence of an economic recovery.
While Mr. Chamoun also has a “buy” rating on CP, he said he would revisit his estimates after its weaker-than-expected first quarter yesterday. He has $53 price target on the stock, noting its revenue declines overwhelmed its cost-cutting efforts during the first quarter.