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CN Rail (TSX:CNR) vs. CP Rail (TSX:CP): Which Is the Better Rail Stock for 2020?

Joey Frenette
FREIGHT TRAIN

It’s the timeless battle of Canadian railway stocks. While they tend to trade together on any given day at any time, only one name offers a better value for investors.

Today, rail stocks are staging a recovery after a relatively sluggish past year. While both Canadian National Railway (TSX:CNR)(NYSE:CNI) and Canadian Pacific Railway (TSX:CP)(NYSE:CP) are back on the right track, only one of the two trades at a discount to its intrinsic value.

Without further ado, let’s get right to it and look at each railway to see how each has fared of late:

CN Rail 

CN Rail retains the title of North America’s most efficient railway thanks in large part to CEO Jean-Jacques Ruest, a man who’s proven that he’s right for the job after a slight fumble by his immediate predecessor.

While many investors treat the boring old-fashioned rail stocks as one and the same, CN Rail has proven time and time again that it’s able to zig as its peers zag — that means bucking industry trends with volumes that have been holding their own at a time when the industry is suffering from falling volumes.

The rail’s operating ratio (currently at 58%) continues to impress in spite of less-than-stellar industry-wide conditions. Management now expects high-single-digit EPS growth, which, while disappointing, is impressive when you consider that EPS growth could have easily been in the mid-to-low single-digits if it weren’t for CN Rail’s operational efficiency.

At the time of writing, the stock trades at 19 times next year’s expected earnings and 13.24 times EV/EBITDA, both of which are in line with historical averages. The stock isn’t a steal by any stretch of the imagination, but given the magnitude of stability and long-term dividend growth potential you’re getting, it can’t hurt to be a buyer at $125 and change.

CP Rail

Similar to CN, CP Rail has held its own amid the industry-wide decline in volumes while continuing to do well on the efficiency front, with a record operating ratio of 56.1%, which marked a 220 basis point improvement on a year-over-year basis.

While CP isn’t the same high-growth play it was back in the Hunter Harrison days, it’s still a dividend growth king that’s capable of delivering outsized results over time under Keith Creel, a man trained by Harrison during CP Rail’s golden years.

CP Rail felt a bit of pain in its latest quarter thanks to year-over-year declines in potash. Given that CP Rail is a major transporter of bulk commodities across the nation, the company appears to be more vulnerable to a drastic slowdown in the commodity-weighted Canadian economy relative to CN Rail.

If we were to enter a recession over the next year or so, CP Rail would likely fall much faster and much harder than CN Rail (shares of CP fell over 60% in the financial crisis, while CN stock essentially took on half the amount of damage).

Moreover, as Ryan Vanzo pointed out in his prior piece, CP Rail stock could be subject to a valuation correction should growth expectations die down. You can only squeeze so much juice from an orange, and now that operating ratios are as high as they are, there’s not much in the room for further improvement.

CP stock trades at 16.9 times next year’s expected earnings and 12.8 times EV/EBITDA, slightly lower than that of CN Rail, and for good reason. CP stock is a riskier bet that could get crushed in a severe economic downturn.

And the winner is?

Both rails have been faring very well recently. And while it looks like CP Rail is looking to steal CN Rail’s title of North America’s most efficient railway, I don’t believe that CP will be able to retain the title over the long haul. CP Rail is more vulnerable come the next recession, and I see it as having little room for further growth.

Although CP Rail looks cheaper based on traditional valuation metrics, I view CN Rail as the cheaper stock given its premium attributes and recession resilience.

The winner is CN Rail by a country mile.

Stay hungry. Stay Foolish.

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Fool contributor Joey Frenette owns shares of Canadian National Railway. David Gardner owns shares of Canadian National Railway. The Motley Fool owns shares of and recommends Canadian National Railway. CN is a recommendation of Stock Advisor Canada.

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