I Think They Can: 2 Undervalued Railway Stocks That Could Chug Higher

CN Rail (TSX:CNR) and CP Rail (TSX:CP) won’t make you rich, but they can help you meet your retirement goals over the long haul!

Joey Frenette

Joey Frenette is a journalist, University of British Columbia graduate, ex-engineer, Warren Buffett fanatic, and Fool who's completed CFA Level 1. He’s been investing since 2014 and is always on the hunt for value, regardless of the market "weather." Before writing at The Motley Fool, Joey worked as an analyst/developer at several Canadian small- and mid-cap software firms, including Syscon and Avigilon. Beyond Motley Fool, Joey’s work can be found at TipRanks and InvestorPlace. Follow or send him a message on X (or Twitter) @realJoeFrenette

Published September 20, 2023 1:45 pm EDT

| More on: CNRCP

The railway stocks have been feeling the hit of macro headwinds lately. Though only time will tell if the economy can escape 2024 without falling into a recession, I still think the rail stocks are worth watching if you’re looking for long-term value options.

Here in Canada, we have two of the better railways out there. CN Rail (TSX:CNR) and CP Rail (TSX:CP) (or Canadian Pacific Kansas City) are the top players here on the TSX Index. Relative to the U.S. rail plays, though, they can be just a tad on the expensive side.

Of course, a premium multiple is warranted, given that Canadian railways tend to be best in breed. CN Rail does have a rich history of delivering above-average efficiency numbers. Though the company has fallen off the tracks a bit, I do not doubt the firm will be able to improve its operating ratio (a metric unique to the railways) over the years.

In this piece, we’ll have a closer look at two railways that I think could make a great bang for your buck over the next year and beyond.

CN Rail

CN Rail is a solid Canadian railway that’s in a major rut right now. The stock suffered a correction and is now off around 12% from its all-time highs. At $152 and change, I view CNR stock as a great value play, given its long-term dividend-growth potential. The stock trades at 19.6 times trailing price-to-earnings, with a nice 2.02% dividend yield.

Of course, CNR stock may not be the cheapest railway on the planet. However, given the extensive track network that spans North America, I think you’re getting very high quality for a reasonable price. The only knock against the stock is uncertainties regarding management. It’s never ideal to have a revolving door for chief executive officers.

Over the last decade, the company has seen Claude Mongeau, J.J. Ruest, and, now, Tracy Robinson at the helm. Only time will tell if Robinson will be staying for the long haul. Regardless, CN Rail needs a catalyst to bring it back on its market-beating track.

Of the two rail plays in this piece, CN Rail stands out as one of the better options right now.

CP Rail

CP Rail stock looks full of growth potential after its acquisition of Kansas City Southern! Still, the stock isn’t cheap at 22.9 times trailing price to earnings. It’s much pricier than CN Rail, and even most of the rail plays in the U.S.

On a relative basis, CP could find itself at risk of a bigger dip should Canada sink into a recession. Intermodal container volumes weren’t hot in the latest quarter. And though it would be nice to get more operating ratio guidance for the second half, I have faith in management’s abilities to keep driving efficiencies for investors.

Unless you’re a raging bull on the concept of near-shoring, CP Rail seems like a less attractive pick relative to its peer group.

Bottom line

Canadian railway stocks have been up against it so far this year. Still, any dips should be viewed as opportunities to buy for the long haul. Between CN, CP, and U.S. railways, my favourite has to be CN Rail. Sure, CN’s managers aren’t my favourite, but given the wonderful assets and what I believe are relatively muted expectations put in place by analysts, I think CNR stock could have the most upside for the group.