Protect your investments with a deep moat – canadian national railway company (nyse cni) seeking alpha power definition physics electricity


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There are many different types of investors and just as many different strategies that they follow to achieve success. As a high net worth investor in my early 50s, I focus on generating an income from my companies and am a more conservative investor. I want to know that the companies that I own are solid and protected from competitors that might threaten their financial stability and the income that stability generates for their shareholders. One of the basic tenants of conservative investing is the idea of partnering with companies that have built a deep moat to protect their businesses. Canadian National Railway (NYSE: CNI) is one of those companies. Building a Moat

Like the castles of the Middle Ages protecting their security by digging deep moats and building high walls to fend off enemies, there are companies who implement this same strategy to great effect. Canadian National has been around for more than 100 years and is the only transcontinental railway that has built a network that connects it to three coasts, the Atlantic, the Pacific and the Gulf of Mexico.

That network includes over 20,000 miles of track along corridors that move it through the heartland of North America connecting importers and exporters to key deep water ports. So if you were a competitor and you wanted to recreate this access, it would not be possible. In an era when building any infrastructure means obtaining permission from a multitude of special interests, companies like CN operate with a generous social license. That advantage is the very definition of a deep moat.

Chicago is arguably America’s most important railway hub. All six Class 1 railways intersect in the city and freight is interchanged among the various carriers, up to 25% of all American rail traffic moves through the city. As a result of this congestion it can take up to 72 hours for freight to move through this choke point. In 2009, CN purchased the Elgin, Joliet and Eastern Railway. This was very important because it included a section of track that allowed CN to go around the congestion of the inner core of Chicago providing greater fluidity and a significant time and efficiency advantage. Once again, think moat. In an era where time is money and connecting to your customers in the most efficient means possible, CN is a leader. When Demand Exceeds Supply

In CN’s Q1 2018 they produced results that were a little underwhelming, but not unexpected. The problem was an uncharacteristically harsh winter, which forced train traffic to slow down and, as a result, creating congestion on the rails. Picture a busy highway and it starts to snow — everything backs up and nobody is happy.

Complicating things are that Canadian grain producers were sitting on a bumper harvest and that product had to be moved to ports for export. Oil prices were gaining, there is a shortage of pipeline capacity and that product had to get to market. The Port of Prince Rupert has increased capacity from 850,000 containers to 1.35 million per year and you are the exclusive provider to that terminal as well. CN had a problem with the weather, which created short-term challenges, but another problem was not having the capacity to handle the added demand.

During the Q1 conference call, interim President and CEO Jean-Jacques Ruest addressed the problem by noting how an over focus on building efficiency may have contributed to under investment in their business. To meet this shortfall, CN has committed an additional C$200M of capital expenditure in 2018 bringing their total spending to C$3.4B. This additional investment should restore capacity by the forth quarter and meet the additional demand going into 2019. On the conference call Ruest also touched on pricing improvements supported by this increasing demand.

Despite the efforts of President Trump, the importance of trade with Asia cannot be overlooked. The Ports of Vancouver and Price Rupert offer the shortest distance between Asian and North American markets. CN is the leading provider of rail service in both. CN has recognized this market advantage (moat) and committed itself to growing this business by investing between 20% and 25% of its top line revenue to capital improvements. These investments include additional track, newer and more efficient locomotives, new investments in upgrading their car stock and additional investments in personnel to operate these new trains.

With added investments in new technology, CN is also building on their existing advantages to move product more efficiently through key corridors like Chicago and build on their current position as the most efficient railway in North America. Despite this position, CN has also indicated that they are not going to under invest in their future to support their operating ratio, but rather have it used as a metric of what they do versus who they are. This refocus on service should bode well for customers as well as shareholders. A Good Time to Buy

With all of the negativity surrounding the NAFTA negotiations, poor weather and management uncertainty, CN has watched its stock drop over the past quarter to levels it has not been for quite some time. This despite the fact it increased its dividend in January by 10% and has increased it on average by 18% per year over the last five years. Currently, CN trades at a P/E of 13.8, which is below its five-year average of 18.57. I don’t expect this situation to last for long. They say success in the market is based more on time in the market than timing the market. I have owned CN Rail for a very long time and it and its wide moat have been very good to me. I would feel comfortable recommending this stock to any long-term investor.