The folks at Euro Pacific Capital, the brokerage built and owned by Peter Schiff, released their June Global Investor newsletter late last week — and, as they usually do, they teased a specific investment that they’re interested in.
Now, this isn’t quite the same as our typical teaser target — Euro Pacific isn’t selling subscriptions to a newsletter, they’re trying to get new brokerage clients to sign up for accounts and start generating commissions for their brokers and “Investment Consultants.” That means they’ll probably tell you the name of the company if you want to call and ask one of their consultants — and they’ll probably throw in a sales pitch while they’re at it.
I have no interest in calling Schiff’s folks at the moment (OK, fine, I’m probably not ever going to want to call them), but I can at least tell you what the stock is that they’re hinting at.
The Global Investor newsletter isn’t up on their website yet, but it is free and it’s sometimes interesting — the latest issue will probably be up here at some point fairly soon.
But the basic gist is that international trade with Asia is benefiting the Canadian transport sector, as evidenced by growth in container volume at the Port of Vancouver of 10.3% in 2010, and year over year growth accelerating in April to over 12%. The sector spiel is closed out thusly:
“Within the Canadian transportation group, we believe one sector is best poised to benefit from the secular international trade growth story with Asia. Container traffic, for example, has grown from 16% of sector revenue in 1990 to 23% in 2010, with the international business being the highest growth driver. Previously announced terminal expansion projects in the west coast of Canada (outside of the port of Vancouver) are also expected to benefit this sector materially over the next five years.
“It is also our view that this sector seems well poised to grow Earnings Per Share even in a flattish-to-potentially slowing global economic environment. Overall, it has had a consistent recent history of being able to grow EPS double digits during periods of flat to slightly declining mid-single digit volumes as they did successfully in 1991, 2001, 2006, 2007 and 2008 when volumes were flat to -4%.”
So what’s the investment that they’re teasing? Here are the details:
“We believe this company has the best guidance for continued pricing and productivity improvements. We also like this name considering its exposure to one of the most rapidly growing container seaports in the Canadian west coast, providing a potential long-term EPS upside of C$0.65 per year underpinned by the rising trade with Asia. Also, this Class I has been the best performing in its class in terms of margins and returns with free cash flow returns exceeding the other Class Is by nearly 400 bps over 10 years. Since 1999, the company has raised dividends 12 times and has consistently repurchased shares in eight out of the last nine years dating back to 2002. The stock has a current dividend yield of just under 2%.”
Being actual registered brokers and not marketing copywriters, they are also a bit more careful with their language (which the sane half of us appreciates, though we also always love over-the-top hypetastic promises) … so they include some risks as well:
“The company risks are:
“Potential for greater regional price competition along certain lanes; Over-exposure to the industrial commodities segment at 40% of freight revenues; Exposure to likely Canadian grain volume headwinds this year versus last season; and Potential for a protracted sub-par economic environment.”
So, as always, business will be good unless it isn’t, right? What, then, is our stock?
This is Canadian National Railways (CNI)
I haven’t written about CNI in a long time, I think the last time I saw them aggressively teased was way back in 2008, when Warren Buffett was early in his railroad investing strategy (he had bought in big to Burlington Northern, but hadn’t yet offered to take over the whole company) and David Gardner pitched his idea for the “new silk road” just as the Fall 2008 crash was getting underway.
And CNI has certainly done better since then than their most obvious competitor, Canadian Pacific (CP) — not that they really compete directly, since most rail lines have something close to an effective regional monopoly, but they’re the two large Canadian railroads.
Canadian National, which bills itself as “North America’s Railway” and tries to go by the name CN to emphasize their larger business, is pretty well diversified as railways go — their route map touches the great lakes, Canadian west and east coasts, and, with a line that pretty closely tracks the Mississippi, the US Gulf Coast. Almost all of their business is either within Canada and the US or between those two countries, but 25% of their volume does go to Asia from Vancouver and their other deep water port in BC, Prince Rupert — and Prince Rupert is where growth is expected to come from, as the port grows in size and takes some container business away from more congested West Coast ports and terminals.
CNI has been on a pretty steady climb over the last two years — like most railroads, their success is largely a function of the economy … they are modernizing and improving their business in many ways, but they will continue to depend on demand for profits, and demand for most railroads depends not only on the container traffic from Asia, which is growing in importance for CNI, but more importantly on coal and grain shipments. And coal and grain demand depends on global growth, which is why the railroads took a tumble back in 2008 when everyone was afraid that we would enter a new dark age.
Railroads are great businesses, as Warren Buffett has clearly said many times — it’s a toll business and high energy prices mean they have considerable pricing power, since rail is far more efficient than truck transport at moving heavy stuff across the country, and many rail lines are still enjoying the investments that were made in lines and rights-of-way more than 100 years ago. Clearly there’s room for improvement as CNI and others invest in higher tech trains, improve scheduling, and improve railways to increase speed and carrying capacity, but it’s basically a simple business: They’ve built the railways, they own the ports, they’re somewhat price-regulated but they can certainly charge a profitable fee for moving stuff. As long as people continue to want to move more stuff, and as long as their assets remain irreplaceable, they should be able to grow their revenue at least as fast as the economy grows, and the value of their assets should more than keep up with the rate of inflation.
Which doesn’t, as we saw in the Fall of 2008, mean that the stocks always go up. Still, CNI, which I think is the second largest “pure play” North American railroad company (market cap about $34 billion, a ways behind Union Pacific’s $50 billion), has been growing dividends, using debt to expand (which doesn’t bother me so much with asset-intensive businesses like railroads), and significantly outperforming the much smaller Canadian Pacific, which arguably has a more local Canada/Midwest US network (though CP does also send heavy traffic through the Port of Vancouver).
The dividend is fairly small at the moment, just under 2% annually, but it has also doubled over the last five years — if they keep up that kind of dividend growth, a patient investor’s compounding can build a position pretty nicely. They trade at a reasonable valuation, though most folks wouldn’t call it dirt-cheap for the historically slow-growth railroad sector (trailing PE around 15, estimated forward PE of 13), but that valuation is pretty much in line with how folks value railroad’s in this commodity-driven era, most of the big companies trade at similar forward valuations. CNI has noted that their taxes are likely to be higher this year, and that they do notice some pressure from a higher Canadian dollar, but they also have been quite aggressively projecting earnings per share growth of as much as 15%.
So are you feeling confident enough to buy a railroad stock near a 52-week high? Think that the message these shares are sending about continued strong demand for coal and wheat is the right one? Let us know with a comment below.
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