Why, Even in a Jet Age, We Still Ride the Rails

July 28, 2017 Edward Golding

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As I recently reclined aboard VIA Rail train #656 on my way home from Montreal to Ottawa, I couldn’t help but appreciate how comfortable the journey was, compared to my usual trip by air.

The ride gave me opportunity to think about the role of railways in our economy and how our investments in Canadian railroad companies have benefited our clients­—why you might count on a freight train or two in your MD portfolio.

Solid economic fundamentals... and great leg room

While I rarely travel by train, more than 82 million passengers travelled on Canada’s railways in 2015 according to the Railway Association of Canada. Not only are rails a means of travel, they are critical in delivering goods, from your electronic devices to what you just ate for breakfast.

The rail industry supports a wide range of our economy, transporting everything from manufactured and finished consumer goods to raw materials and resources, coast to coast. We’ve seen a trend to rail shipping away from trucking, driven by lower environmental impact and improved productivity from a logistics standpoint.

Canada’s freight railways move almost 328 million tonnes of goods a year including essentials like cars, food and fuel. Exports are a critical component of our commodity-based economy and, in 2015, railways delivered more than $150 billion of Canadian exports to global markets.1

Why there’s a train set in your portfolio

Shiny and new technology companies like Netflix and Facebook get lots of press and attention, but traditional railroad companies remain very relevant in a core Canadian equity portfolio.

Two firms dominate the industry, Canadian National Railway (CNR) and Canadian Pacific Railway (CP), which are both icons of Canadian corporate history. 

Montreal-based CNR was incorporated in 1919 and is expected to have sales in excess of $13 billion and an enterprise value of almost $85 billion by the end of 2017. Headquartered in Calgary, CP was incorporated in 1881 and is expected to have sales of about $6.5 billion and an enterprise value of $49 billion by the end of 2017. 

Both CNR and CP are important components to the S&P/TSX Composite benchmark, averaging a weight of 3.21% and 1.46% respectively over the past five years. In that time MD has, on average, been overweight both companies relative to the benchmark in both the MDPIM Canadian Equity Pool and MD Equity Fund. The overweight to both companies contributed to outperformance in both funds, as CNR has an annualized return of 20.45% and CP has an annualized return of 21.46% over that period—outperforming the benchmark return of 7.24%.

Investments that move along the right track

MD remains overweight both CNR and CP, as each company is sustained by strong market presence, cost competitiveness and ability to command pricing power across well-diversified markets.

“Overall, we believe the outlook for the Canadian railroads is robust, given the health of the underlying economy. With strong underlying fundamentals, both CNR and CP generate strong cash flow as they leverage their networks, driving efficiency and productivity improvements while realizing pricing gains for the value-add services they provide,” says Timothy W. Caulfield, Director of Equity Research at Franklin Bissett Investment Management, a subadvisor to MDPIM Canadian Equity Pool and MD Equity Fund.

A global ticket to ride

“As North American economies perform well and global trade improves, both CNR and CP are well positioned to add volume, particularly if oil prices rise, given a scarcity of pipeline access”, says Heiki Altosaar, Portfolio Manager with PCJ Investment Counsel a subadvisor on MDPIM Canadian Equity Pool.

“While the Canadian dollar strength and droughts in U.S. wheat-growing regions may cause potential headwinds, these are more than reflected in expectations. We expect volumes to continue to grow at ‘GDP-plus’ rates with an uptick in pricing. This, coupled with productivity improvements, should drive low double digits earnings per share growth,” he says.

On a roll toward financial independence

As train #656 barrelled down the tracks to take me home, I felt assured my ride would be smooth, on time and meet my expectations. I can’t help but hold that same level of confidence the railroads will help deliver a similar experience in MD portfolios on our journey to financial independence.
 

1 Railway Association of Canada

 

About the Author

Edward Golding

Edward Golding, CFA, MBA, is an Assistant Vice President with the Investment Management and Strategy team at MD Financial Management. He oversees the Canadian, Dividend and U.S. equity mutual funds and investment pools at the firm.

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