John Heinzl is the dividend investor for Globe Investor's Strategy Lab. Follow his contributions here. You can see his model portfolio here.
As Warren Buffett once observed, investing is like baseball – with one key difference: You can watch as many pitches go by as you like and only swing when the perfect one comes along.
Right now, for instance, I'm waiting for a fat pitch from Canadian National Railway Co.
Hurt by the slump in commodities such as oil, coal and metals, shares of Canada's largest railway have skidded about 18 per cent from their 2015 high of $88.89, marking a rare stumble for a stock that had been going virtually straight up for years.
While an 18-per-cent discount is nice, particularly given CN's reputation as one of the best-run North American railways, I'm not swinging just yet: With rail volumes expected to remain under pressure in 2016 and the economic outlook uncertain, CN's shares could potentially fall further. A general market sell-off – triggered by economic woes in China, geopolitical events or some other factor – would also likely send CN's shares lower.
How low would they have to go before I would be interested?
On Tuesday, CN closed at $72.99, down $1.46, on the Toronto Stock Exchange. If the stock were to fall below, say, $70 – which it did briefly in January – I would consider adding it to my personal portfolio. That would imply a price-to-earnings multiple, based on 2016 estimates, of about 15 – toward the low end of CN's five-year historical range.
If the stock doesn't get into my strike zone, well, there will be plenty of other pitches to swing at. Here's why I like CN and would buy it at the right price.
It's a dividend growth machine
Dividend investors often give CN a pass because of its modest yield (currently 2.1 per cent). But make no mistake: It's one of the most reliable dividend growers around. Since the company went public in 1995, it has raised its dividend for 20 consecutive years, including a 20-per-cent increase (to $1.50 annually) announced in January. The increase reflects the company's "confidence in the future … and the strength of our balance sheet," chief executive officer Claude Mongeau said on the fourth-quarter conference call. In the past decade alone, the dividend has more than quadrupled, and there are almost certainly more increases to come. "The consistent increase in the dividend demonstrates CN's solid cash flow generating capability even during periods of cyclical weakness," RBC Dominion Securities analyst Walter Spracklin said in a note.
The payout ratio is conservative
Even after the recent increase, the new dividend represents a payout ratio of just 32 per cent of estimated 2016 earnings, which gives the dividend ample protection should the economy soften further. CN's goal is to gradually raise its payout ratio to 35 per cent, which suggests that the dividend will likely grow at a faster clip than earnings per share. What's more, CN uses its cash flow to buy back its own stock: "Given the current stock price, we … expect the company to complete the current $2-billion share buyback program by the end of the third quarter of 2016," Desjardins Securities analyst Benoit Poirier said in a note.
Earnings are still growing
CN management indicated that it expects "mid-single-digit" growth in earnings per share in 2016, with a weak Canadian dollar helping to offset lower volumes. Also working in CN's favour, the company's diversified rail network – its 32,000 kilometres of track stretch from the Atlantic to the Pacific coasts of Canada and south to the Gulf of Mexico – results in lower exposure to commodities than other railways and higher exposure to consumer-oriented areas such as autos and intermodal container freight, which have been more resilient. "During this period of uncertainty for bulk commodities, CN offers investors a more 'defensive' railroad given its mix of business and network reach advantages," CIBC World Markets analyst Kevin Chiang said in a note.
Guidance might be conservative
Even though the commodities slump is expected to pressure CN's 2016 results – the first quarter, in particular, will face some tough comparisons with a year earlier – some analysts say CN could exceed its own earnings growth guidance for the year. "We highlight to investors CN's penchant for guiding with a conservative hand," said RBC's Mr. Spracklin, who forecasts earnings per share growth of 8 per cent. He expects volumes to improve in the second half, with CN's intermodal business potentially benefiting from an expansion of the Panama Canal that will increase traffic through ports in Mobile, Ala., and New Orleans, La.
Closing thoughts
Railways are a barometer of the economy, so a slowdown in growth would affect rail shipments and CN's stock price. Longer term, however, CN will almost certainly continue to increase revenues, earnings and dividends. That's why I'm standing at the plate, bat in hand, waiting for the stock to enter my strike zone.