(The following article by Paul Vieira was posted on the Financial Post website on June 9.)
TORONTO — Whether it’s his southern charm, drive to find efficiencies or ability to make his trains run on time, the markets are drawn to Hunter Harrison, chief executive of Canadian National Railway Co. It shows in the stock (CNR/TSX), which hit a 52-week high on Monday, of $57.78, less than two weeks after the Memphis-raised, silver-haired CEO wowed company watchers at a meeting with analysts.
Mr. Harrison and other senior executives outlined the railway’s five-year plan that targets annual revenue growth of 5%, share profit increases of 8% to 12% a year, and an operating ratio — the key industry measure that expresses expenses as a percentage of revenue — below 65% by 2009.
Some in attendance were in awe.
“Here’s a company that already sets the gold standard for the industry and yet most of management isn’t satisfied with its current performance,” James Valentine, a railway analyst at Morgan Stanley in Chicago, wrote in a note to clients. “The [analysts’ meeting] gave us a chance to witness how Hunter Harrison’s commitment to excellence is showing up more pronounced and deeper within the organization.”
The stock, which split on a three-for-two basis last February, has climbed from a low of $50.10 in March, when it was mired in a month-long strike by mechanics, customer service staff and intermodal yard workers.
CN’s share price has also benefited from its status as a defensive play during the current uncertainty about where the market is headed. The railway’s fundamentals remain solid, as its operating ratio stands at an industry-leading 72.5% and it generates operating margins in the 30%-plus range.
These strong basics are priced into the stock, which is trading at 1.8 times book value. Moreover, CN’s trailing 12-month price-earnings ratio of 15.73 is slightly above its main domestic rival, Canadian Pacific Railway Ltd. (15.3), and U.S. competitor, Union Pacific Corp. (14.4). Nevertheless, CN is trading at a discount to the four-member Standard & Poor’s 500 railway group.
Nine analysts who cover the company have price targets — ranging from as low as $59.30 to as high as $65 — that are above yesterday’s closing price of $57.49 on the Toronto Stock Exchange.
“Given their track record of strong execution and industry-leading financial performance, we believe CN is likely to execute well on its key strategies which should drive continuing strong financial performance and significant growth,” said Thomas Wadewitz, an analyst with Bear Stearns in New York, who considers the stock a “core holding” for long-term investors.
The Montreal-based railway operates 28,000 kilometres of track across North America, and Mr. Harrison may add more track with further acquisitions given the free cash flow, of $3.25 a share, CN generates. For now, CN is currently focusing on integrating its Great Lakes Transportation acquisition, and closing its deal to buy BC Rail.
Analysts expect both of those purchases to boost share profit by up to 45 cents by 2006, with Great Lakes having an immediate impact this year.
Adding to the company’s coffers are expected gains from technological advances and reduced payroll costs. Mr. Harrison has said he expects 1,200 jobs to be eliminated in the next 18 months, even though increased volume is on the horizon. CN also expects to shut down a major rail yard and as many as three shops in the next five years, while cutting spending on rail car repairs.
Moreover, the move toward hourly wage agreements with its U.S. staff, as opposed to paying workers based on distance travelled, is expected to achieve annual savings of $55-million, the company told analysts. CN is also looking to reduce its accident-related costs, which run at about $100-million per year.
Besides single-digit volume growth from its bulk, merchandise and intermodal businesses, CN is also looking to the port at Prince Rupert, B.C., as a key engine for growth. The city is recognized to have the West Coast port with the shortest sailing time, by one day, to Asia. CN, with its reputation to transport and deliver goods on time and its pending purchase of BC Rail, has access to the port and wants to capitalize on demand for bulk goods from China. CN’s intermodal business — the use of rail and trucks for shipping — and coal shipments are expected to record sizable gains in business.
Railway analysts note the railway has targeted annual free cash flow growth from an expected $625-million this year to roughly $700-million in 2009. That increase is based on a series of assumptions, such as CN boosting its dividend payout by 1% a year and tax rates double during that five-year period.
If the cash flow projections come true, this would put CN in a position to buy back 10 million of its shares per year, or 3.5% of the outstanding float. But the company may decide to use its cash elsewhere, such as acquisitions.
One factor beyond CN’s control is the price of fuel, currently near 13-year highs. Nevertheless, 56% of the railway’s fuel for 2004 is hedged, and roughly 80% of its revenue is linked to fuel prices. This leaves CN “with a lower level of price exposure than most railways,” Mr. Valentine said.