Dividend Stock Wednesday: Canadian National Railway (CA:CNR)

Note: I use the Stock Selection Guide Software and its methodologies from the CSA to perform the bulk of my analysis on stocks.

Company Profile:

Canada’s largest railroad, operating a network of 14,000 route miles (Dec. 31, 2006) of track in eight provinces in Canada and the Northwest Territories and 6,300 route miles in 16 states in the United States, with revenue derived from the movement of a diversified and balanced portfolio of goods including, petroleum and chemicals, metals and minerals, forest products, coal, grain and fertilizers, intermodal, automotive and other (primarily non-freight revenue derived from third parties).

Revenue Profile & Projection:

Let’s start by examining management’s ability to convert the companies products and services into increased sales on a consistent basis, year after year. To pass the revenue test, the company must possess the following two attributes:

1. a steady and consistent revenue uptrend
2. the ability to continue to grow revenues in the future, giving consideration to such things as demographics and market trends (i.e. the move from film to digital)

The revenue profile:

The revenue profile for CNR is presented below. Based on a visual analysis of this trend, an investor would say the trend for revenues for the company is up, but not in a steep way like we would typically look for. It is up and relatively stable nonetheless.

Revenue projections:

Being conservative, but not too conservative, a revenue growth rate must be extrapolated to project a revenue number 5 years from now. This will not be an exact science but will provide us with a projection of what revenues you can expect the company to generate in the future. This is important because it is revenues that lead to earnings. One important thing to consider is whether revenue growth is accelerating or decelerating – this helps make a judgment call on what growth rate to apply.

Historical Growth Rates:

Study Period	Growth
1 – 10	6.4%
6 – 10	7.2%
1 – 5	6.4
1 – 2	6.3

It is clear from the data, the growth rate in the past few years has been relatively stable over all periods. There was a period of increased growth about 10 years ago, but nothing substantially more than what has been seen on a consistent basis.

Based on the revenue growth rate data, I have chosen a conservative revenue growth rate of 6.0% which would mean, at the end of 2011 the revenue for CNR will be approximately $10,326 million per year.

EPS Profile & Projection:

I want to now move onto looking at the company’s earnings per share – how well the company turns those revenues into earnings for shareholders. To pass the EPS test, the company must possess the following two attributes:

1. a steady and consistent EPS uptrend
2. the ability to continue to grow EPS in the future

The EPS profile:

The EPS profile for CNR is presented below. Based on a visual analysis of this trend, an investor would say the trend for revenues for the company is mostly up.

EPS projections:

Just as with the revenue projections, being conservative, but not too conservative, a EPS growth rate must be extrapolated to project a revenue number 5 years from now. This will not be an exact science but will provide us with a projection of what EPS you can expect the company to generate in the future. Again it is important to consider is whether revenue growth is accelerating or decelerating – this helps make a judgment call on what growth rate to apply.

Historical Growth Rates:

Study Period	Growth
1 – 10	14.5%
6 – 10	8.1%
1 – 5	24.1%
1 – 2	21.9%

It is clear from the data, the growth rate in the past few years has been increasing over the longer period, but in the last two years we have seen the growth rate drop off a bit from 24.1% to 21.9%. Still, very respectable performance from a “steady” industry. I see this as a very high growth rate and somewhat unsustainable as I wouldn’t expect to see established companies in mature industries such as railways earning any more than 10% EPS growth per year. In addition, I have learned from past history that choosing a EPS growth rate that is higher than the revenue growth rate may be unsustainable for a company.

Based on this information and the growing historical growth rates from above, I have chosen a conservative EPS growth rate of 6% which would mean, at the end of 2011 the EPS for CNR will be approximately $4.54 per year. The current year estimate is $3.59, which is a bit higher than the analyst consensus of $3.54.

Dividend History:

As a dividend investor, I of course look at dividends. Usually, I already know at this point that the company at least pays a dividend and has a strong history of increasing their dividend payouts on a consistent basis. The only analysis I do on dividends at this point is to quickly look at the dividend history over time. I want to see at least 10 years of uninterrupted and growing dividend payments to shareholders. The table below presents this data:

Year	Dividends Paid
2006	$0.65
2005	$0.50
2004	$0.39
2003	$0.33
2002	$0.29
2001	$0.26
2000	$0.23
1999	$0.20
1998	$0.18
1997	$0.15

That is some nice strong dividend growth, especially in the last few years.

Share Price Valuation:

I use 2 methods to compare a company’s share price. The first is looking at the dividend yield to see how the current yield compares to the 10 year average yield for the company. The second is determining a buy range for the stock through the analysis of the recent price for $1 of EPS in relation to historical prices. Here is my results of my valuation.

Dividend Yield

Current Dividend Yield: 1.50%
Average Dividend Yield for past 10 Years: 1.40%
Is the current dividend yield higher than the average dividend yield for past 10 years:Yes

The fact that the dividend yield is higher today than its average over the past 10 years, this suggests that the stock is trading at a slight discount to its normal share price. However, this is not enough to go off to make a purchase. I like to look more closely at the P/E ratio to determine what my buy price range should be.

Buy Range

Recent Price (how is the current price sitting in relation to historical averages):

EPS Projected Growth Rate: 6%
Recent P/E ratio: 15.8 (= current stock price dividend by current year projected EPS of $3.73)
Relative P/E ratio: 1.05 (= recent P/E divided by 10 year average P/E)

Based on a relative P/E of 1.05, buying the company today would indicate that we are buying at a premium of 5% compares to the 10 year historical P/E values. This is not a very high premium which might suggest that the shares are trading to fair market value.

Upside Price (based on the EPS projection, what price might we expect if the growth continues on the trend we saw in our analysis of revenue and EPS):

Upside price: $68.55 (= upside EPS in 5 years X upside P/E ratio in 5 years)
Upside P/E ratio: 15.1 (= 10 year average high P/E ratio)

Downside Price (based on the EPS projection, what price might we expect if the growth continues on the trend we saw in our analysis of revenue and EPS):

Downside price: $45.52 (= current price – (1 – 20% decline))

Buy Range

The buy range for CNR is $45.52 to $53.20

This is calculated by:

(Upside Price minus – Downside Price) divided by 3 = $7.68 which is the size of the buying zones I use (buy/wait/sell). The buy zone is simply the downside price plus the zone size.

Summary

Based on CNR’s current price of $56.90, my analysis calls this stock a wait. The company has seen some pretty good years of growth recently, but looking back longer term, the performance is not indicative of a dividend growth stock. That being said, the dividend growth has been very good so if someone is looking for a pretty steady stock, then CNR may fit that bill. Personally, I will wait to see if the stock drops to around the $50 – $52 level before making a purchase.

Disclosure: The Dividend Guy does not own shares in CNR. This is my analysis of the stock and is not investment advice. Do your own research.

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