Acquisition Of Iowa Northern Will Expand Network And Improve Efficiency

Key Takeaways

• Network expansion and improved labor relations are set to boost operational efficiency, reducing uncertainties and enhancing margins.
  
• Strategic investments and initiatives focus on growth in key segments, supporting revenue and earnings increases.
  
• Economic uncertainties, labor disruptions, and volatile fuel prices threaten CN's revenue growth and profitability, while competitive and infrastructure challenges complicate operational stability.

Catalysts

Engages in the rail, intermodal, trucking, and related transportation businesses in Canada and the United States.

• The acquisition of Iowa Northern will extend CN's network into the Iowa grain belt, providing new market access and operational synergies, which are expected to contribute to revenue growth.
  
• The stabilization of labor relations with key unions, including agreements with IBEW and Unifor, will improve operational efficiency and reduce uncertainties, likely enhancing net margins.
  
• The railroad's investment in productivity initiatives, including the DC-to-AC locomotive conversion program, aims to improve fuel efficiency and reliability, supporting margin expansion and earnings growth.
  
• The anticipated recovery of container volumes diverted due to past labor disruptions, along with service reliability improvements, is expected to drive a return to volume growth, positively impacting revenues.
  
• CN's strategic initiatives target growth in key areas such as international intermodal, frac sand, and petroleum exports, with half of the expected RTM growth in 2025 stemming from CN-specific initiatives, which will drive revenue and earnings increases.

Canadian National Railway Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Canadian National Railway's revenue will grow by 5.7% annually over the next 3 years.
• Analysts assume that profit margins will increase from 26.1% today to 28.5% in 3 years time.
• Analysts expect earnings to reach CA$5.7 billion (and earnings per share of CA$9.74) by about March 2028, up from CA$4.4 billion today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 21.6x on those 2028 earnings, up from 19.7x today. This future PE is greater than the current PE for the US Transportation industry at 18.2x.
• Analysts expect the number of shares outstanding to decline by 1.4% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.07%, as per the Simply Wall St company report.

Canadian National Railway Future Earnings Per Share Growth

Risks

• Uncertainties around economic conditions, tariffs, and potential retaliatory measures could negatively impact CN's revenue growth and earnings, especially if a recession or significant inflation occurs in Canada or the U.S.
  
• Labor disruptions, such as strikes and rail shutdowns experienced in 2024, highlight the risk of similar future events leading to operational instability and revenue loss.
  
• Volatile fuel prices present a risk to operating expenses and margins, which could adversely affect profitability if costs cannot be passed on to customers.
  
• The competitive intermodal market, particularly in North America, poses a challenge to CN's volume growth targets and revenue enhancements if competitors outperform in pricing and service reliability.
  
• Infrastructure vulnerabilities, including disruptions from extreme weather or natural disasters, could impair operations, increase costs, and impact net margins by reducing service reliability and customer satisfaction.

Valuation

• The analysts have a consensus price target of CA$167.714 for Canadian National Railway based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of CA$200.0, and the most bearish reporting a price target of just CA$123.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be CA$20.1 billion, earnings will come to CA$5.7 billion, and it would be trading on a PE ratio of 21.6x, assuming you use a discount rate of 7.1%.
• Given the current share price of CA$139.47, the analyst price target of CA$167.71 is 16.8% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.