Canadian National Railway Company updated April 28, 2018

CN rail, Canadian National Railway Company is updated and rated (lower) Buy at $100.65. The As detailed int he report, CN stumbled through this past winter and encountered operational problems when traffic was higher than expected and the weather was worst than expected and they had cut back too much on staff. They had selected a new CEO last year and at that time inexplicably chose an internal candidate with strong financial experience and no operational experience. They terminated that CEO in early March (see my March 5 comment).

After reporting a 13% drop in earnings per share in Q1, the company appears to be forecasting growth of about 9% on average in each of the next three quarters. While the stock is not priced as a compelling buy I think it is worth a look. I plan to buy a few shares and would add to that on dips.

In looking at CN’s financial notes I happened to notice a couple of unusual debt securities that it has outstanding.

CN’s Illinois Central¬† issued U.S. $125 million of 7.70% debentures in 1996 that do not mature until 100 years passed which will be the year 2096. This debt is likely held by institutional investors such as pension funds. In retrospect a 7.70% yield locked in for 100 years was a very astute investment. 100 years is about as close as we normally see to a perpetual debt issue. Perpetual or even 100 year bonds can provide for some eye-popping results when interest rates fall towards zero as they unexpectedly did after these 100 year bonds were issued. I covered some of the math in an article a few years ago.

CN’s BC Rail division issued in 2004 a 90-year non-interest bearing subordinated note. This note is set to pay out at $842 million in 2094. Yet, CN books this as a liability of only $11 million. The liability will slowly grow towards $842 million over the 76 years that remain until maturity.¬† The interest rate on this “zero-coupon” bond is 5.75%. The surprising math is that the investor owning this bond may have paid only $5.5 million. It does seem an odd thing to accept $5.5 million now in exchange for paying out $842 million in 100 years. This shows the staggering impact of something like a seemingly modest 5.75% return when it is compounded over 90 years. CN acquired BC Rail in 2003. It may be that the BC government is the owner of this bond as it was issued close to the time of the acquisition of BC rail from the BC government.

While receiving $5.5 million in return for paying out $842 million in 90 years may not sound like a good deal for CN it may not be that bad. CN effectively starts our borrowing $5.5 million but then since it pays no interest, it effectively borrows the interest each year and in effect at some point this is equivalent to having borrowed a lot of money ($842 million in the end). Currently CN has effectively borrowed 11 million from the investor consisting of the original $5.5 million and now 14 years of accrued unpaid interest.