The wide-moat company remains arguably the highest-quality Class I railroad.
At its 2017 investor meeting, CN
management shared its expectation that the firm will increase EPS by 10% during each of the next five years, fueled by volume outpacing a 3% growth economy, annual rate increases exceeding 2%-3% rail inflation, a mid-50s operating ratio, and yearly share repurchases of around 3% of shares outstanding. These projections are in line with our existing model, which we retain, except that we foresee volume growth about 100 basis points slower. We maintain our wide moat rating and opine that CN remains arguably the highest-quality Class I railroad. However, this is no secret and valuation looks full to us. Shares trade at a rich 21.1 times consensus 2017 earnings and 19.4 times 2018, versus a 17.5 times five-year median and 14.5-20.7 times range for consensus next 12 months P/E. The current market price of CAD 107.57 ($81.77) versus our CAD 89.00 ($67.00) fair value estimate garners CN our 2-star rating.
Keith Schoonmaker, CFA, is director of industrials equity research for Morningstar.
Chief Marketing Officer JJ Ruest presented top-line growth opportunities for the next five years that combined represent CAD 1.5 billion-2.2 billion of incremental revenue (versus a top line of CAD 12 billion in 2016). Intermodal is among the strongest demand sources, with international driven by expansion at Prince Rupert and Vancouver and domestic fed by retail expansion, wholesale partners like J.B. Hunt, and additions to CN's refrigerated container fleet. We expect Canadian grain growth due to crop productivity, and management points to new elevators on its line and expected continued competitive share gains. Related to oil, several new and several expanded petrochemical plants are coming on CN's line in Edmonton, and frac sand demand is vigorously recovering from 2016 in Alberta and Wisconsin. Other recovering commodities include lumber and panel feeding U.S. housing, and coal opportunities at mines opened or scheduled to open by Grande Cache and Conuma. Our existing projections increase revenue CAD 2.2 billion from 2017 to 2021.
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