Canadian National

The North American freight rail industry operates as three duopolies, with two rail networks operating across the East, West and Central US into Canada each. These rail networks have very high entry barriers, given the prohibitive cost and regulatory challenges associated with trying to lay a new rail network. More than half (55%) of rail industry revenue has no substitutes, while 45% of freight revenue could be substituted by trucking. Given this strong industry position and ability to add volume at low incremental cost, rail has been able to price above its cost inflation over the long term.

Three important factors make it an attractive time to invest in the rail operators. Firstly, the rail companies have implemented Precision Scheduled Railroading, a method of operating the railroad more efficiently, which should allow them to improve their service levels and lower their costs. Secondly, rails are four times more fuel efficient than trucking, and with higher fuel prices, their relative price discount to trucking increases further. Finally, longer-term, the increasing need for supply chains to decarbonise favours rail freight over trucking, given its greater fuel efficiency. A 2% shift in volume from trucking to rail freight would increase the rail market size by 14%, given that the truck market is so much larger.

Canadian National was undermanaged prior to the appointment of a new CEO, Tracy Robinson, but is now focused on operating the network according to Precision Scheduled Railroading principles. Recently reported operating metrics such as dwell time and velocity have been good. They are working to be more disciplined in sticking to the rail schedule to improve asset turns and service levels, better curate the book of business they sell according to the schedule and ensure that the operating and marketing teams work in lockstep. Canadian National trades at 20.7 times forward earnings and should grow earnings by 12% a year over the next five years and offers a 2.7% forward dividend yield.

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