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While most of the attention surrounding railroads these days is focused on the battle between hedge fund Pershing Square and Canadian Pacific, Canada's other leading railroad, Canadian National Railway (CNR-T), continues to be best in class.
Analysts at Morningstar said in a note to clients that CN Rail continues to set the standard in railroad profitability, after maintaining the best operating ratio -- a measure of efficiency -- for the past decade. Operating ratio is found by dividing operating expenses by revenue, meaning a lower number is better.
"CN is not resting on its laurels, but continues to drive down its operating ratio, which was 63.5 percent in 2011," Morningstar's Keith Schoonmaker said. "We don't think the shares are currently undervalued, but we do think CN is the low-risk option among railroads."
Schoonmaker points to CN Rail's push into new markets as a foundation for the company's springboard for further growth.
"CN targets doubling its coal franchise by 2016. While coal constituted just 7 percent of the 2011 revenue portfolio, terminals CN serves at Prince Rupert, Vancouver, and New Orleans are all increasing export capacity," he said.
CN is also looking to tap into the North American oil and gas boom. "Unknown just a few years ago, new oil and gas mining techniques demand frac sand, and CN's track is well placed to serve sand sources in Wisconsin. Indeed, management says frac sand could be a $300-million business by 2016," he said.
Canadian Pacific's dominant position in the potash export market is also on CN's radar. Schoonmaker says that while CN holds about 60 percent the domestic potash shipping market, it holds a much smaller share in the export market.
"CN aspires to expand its share to half of the exported potash market by 2016 from nil in 2009. This would increase sales from $55 million in 2009 to around $300 million in 2016," he said.
A resurgent U.S. housing market will also benefit the railroad operator.
"At 20% of revenue just a few years ago, CN is more exposed to lumber and paper products than are other railroads; while the paper market is in secular decline, we believe the U.S. homebuilding market will eventually recover and rekindle lumber demand -- requiring CN's services and sparking earnings growth," Schoonmaker said.