Canadian National Railway (USA) (NYSE: CNI) easily outperformed the Industrials sector by 25.1% as it relates to ROE, producing a strong 35.2% compared to the sector’s 10.1%. But what is more interesting is whether Canadian National Railway will continue to achieve superior returns moving forward. The DuPont analysis is a useful tool that may help us determine this. In my analysis below, I’ll use the DuPont model to reveal what’s really driving the company’s strong ROE.
Canadian National Railway’s ROE Trends
Return on equity or ROE represents the percentage return a company generates on the money shareholders have invested.
ROE = Net Income To Common / Average Total Common Equity
In general, a higher return on equity suggests management is utilizing the capital invested by shareholders efficiently. However, it is important to note that ROE can be impacted by management’s financing decisions such as the deployment of leverage.
Canadian National Railway’s recent ROE trends are illustrated in the chart below.
source: finbox.io data explorer – ROE
It appears that the return on equity of Canadian National Railway has generally been increasing over the last few years. ROE increased from 23.2% to 24.0% in fiscal year 2016, increased to 35.2% in 2017 and the LTM period is also its latest fiscal year. So what’s causing the general improvement?
What’s Causing Canadian National Railway’s Improving Return On Equity
A less used approach although being much more intuitive, the DuPont formula is another way to calculate a company’s ROE. It is defined as:
ROE = Net Profit Margin * Asset Turnover * Equity Multiplier
Created by the DuPont Corporation in the 1920s, the analysis is a useful tool that helps determine what’s responsible for changes in a company’s ROE. It highlights that a firm’s ROE is affected by three things: profit margin, asset turnover, and its equity multiplier or financial leverage.
Analyzing changes in these three items over time allows investors to figure out if operating efficiency, asset use efficiency or the use of leverage is what’s causing changes in ROE. Strong companies should have ROE that is increasing because its net profit margin and/or asset turnover is increasing. On the other hand, a company may not be as strong as investors would otherwise think if ROE is increasing from the use of leverage or debt.
So let’s take a closer look at what’s causing Canadian National Railway’s improving returns.
Canadian National Railway’s Net Profit Margin Trends
A promising sign for shareholders, Canadian National Railway’s net profit margin has increased each year since 2015. Margins increased from 28.1% to 30.2% in fiscal year 2016, increased to 42.1% in 2017 and the LTM period is also its latest fiscal year.
As a result, the company’s improving margins help explain, at least partially, why ROE is also improving. Now let’s take a look at Canadian National Railway’s efficiency performance.
Canadian National Railway’s Asset Turnover Trends
It appears that asset turnover of Canadian National Railway has generally been up and down over the last few years. Turnover decreased from 0.34x to 0.32x in fiscal year 2016 and then increased to 0.35x in 2017.
source: data explorer – asset turnover
Therefore, the company’s ROE improvement is not as a result of its asset turnover performance which has generally been decreasing.
Finally, the DuPont constituents that make up Canadian National Railway’s ROE are shown in the table below. Note that the table also compares Canadian National Railway to a peer group that includes Canadian Pacific Railway Limited (NYSE: CP), Norfolk Southern Corporation (NYSE: NSC), Union Pacific Corporation (NYSE: UNP) and Kansas City Southern (NYSE: KSU).
source: finbox.io’s DuPont model
In conclusion, the DuPont analysis has helped us better understand that Canadian National Railway’s general improvement in return on equity is the result of steadily improving net profit margin.
The DuPont approach is a helpful tool when analyzing how well management is utilizing shareholder capital. However, it doesn’t necessarily tell the whole story. For example, how do the company’s ROE trends compare to its peers or sector? How about in absolute returns? I recommend that investors continue to research Canadian National Railway to gain a better understanding of its fundamentals before making an investment decision.
Author: Brian Dentino
Expertise: financial technology, analyzing market trends
Brian is a founder at finbox.io, where he’s focused on building tools that make it faster and easier for investors to research stock fundamentals. Brian’s background is in physics & computer science and previously worked as a software engineer at GE Healthcare. He enjoys applying his expertise in technology to help find market trends that impact investors.
Brian can be reached at email@example.com.
As of this writing, Brian did not hold a position in any of the aforementioned securities and this is not a buy or sell recommendation on any security mentioned.
Read more awesome articles like this one on VintageValueInvesting.com!