CANADIAN NATIONAL RAILWAY CO. $102 (Toronto symbol CNR; Conservative Growth Portfolio, Manufacturing & Industry sector; Shares outstanding: 424.1 million; Market cap: $43.3 billion; Price-to-sales ratio: 4.3; Dividend yield: 1.7%; TSINetwork Rating: Above Average; www.cn.ca) operates Canada’s largest railway. The company’s 32,350-kilometre network stretches across Canada and through the U.S. Midwest to the Gulf of Mexico.

Ottawa nationalized CN in 1918 because of the vital role the company played in Canada’s early growth. In 1995, CN became a publicly traded company. Unlike CP, Ottawa limits a single investor’s ownership in CN to 15%.

Due to a drop in freight volumes during the recession, CN’s revenue fell 13.1%, from $8.5 billion in 2008 to $7.4 billion in 2009. Revenue recovered to $8.3 billion in 2010 and surged to $9.9 billion in 2012.

Earnings fell 2.2%, from $1.9 billion in 2008 to $1.85 billion in 2009. CN is an aggressive buyer of its own shares. Due to fewer shares outstanding, earnings per share fell just 0.8%, from $3.95 to $3.92. Earnings then soared to $6.12 a share, or a total of $2.7 billion, in 2012. If you disregard an income tax recovery and other unusual items, CN would have earned $5.61 a share in 2012, up 15.9% from $4.84 in 2011.

In the three months ended March 31, 2013, CN earned $519 million, down 0.8% from $523 million a year earlier. That’s mainly because extreme cold and heavy snow in western Canada delayed trains and lowered the amount of goods that CN shipped. However, earnings per share rose 3.4%, to $1.22 from $1.18, on fewer shares outstanding. Even with the bad weather, revenue rose 5.1%, to $2.5 billion from $2.3 billion.

Investments in new railcars paid off

The company recently increased its capacity to transport crude oil from western Canadian producers. That pushed up its revenue from shipments of petroleum and chemicals by 16.6% in the latest quarter. CN also reported gains from shipping intermodal containers (up 7.0%), metals and minerals (up 3.3%), forest products (up 2.4%), automotive (up 1.5%) and grain and fertilizers (up 1.0%). These gains offset a 1.2% drop in coal revenue.

CN’s operating ratio in the quarter worsened to 68.4% from 66.2% a year earlier. (Operating ratio is calculated by dividing regular operating costs by revenue. The lower the ratio, the better.)

However, the company’s efficiency should improve over the balance of 2013. That’s because CN continues to invest in better trains and tracks. For example, it is buying new locomotives with distributed power capability. This unique technology will let CN run longer trains, particularly in cold weather. By 2014, about half of CN’s high-powered locomotives will use this technology.

CN is also improving its long-term efficiency with new terminals. It recently opened its new $200-million intermodal transfer station near Calgary. This facility will speed up the shipment of goods from Asia to Eastern Canada and the U.S., and vice versa. In June 2013, CN will open a new intermodal terminal in Joliet, Illinois. That will let the company’s clients in the U.S. Midwest avoid congested rail yards in Chicago.

Oil-by-rail is a fast-growing business

Another area of growth for CN is shipping crude oil by rail. The company expects its oil volumes to rise to over 60,000 carloads in 2013 from just 5,000 in 2011. That’s why CN is building a new rail terminal in Mobile, Alabama, that will help oil producers in Western Canada and North Dakota’s Bakken region ship their crude to refineries on the U.S. Gulf Coast.

Oil volumes could suffer if the U.S. approves the Keystone XL pipeline. However, this business’s outlook remains bright, because railways can reach more locations than pipelines.

In all, CN expects to spend $2.0 billion on new equipment and other upgrades in 2013, up from $1.7 billion in 2012. The company’s sound balance sheet will let it keep expanding: its long-term debt of $5.9 billion (as of March 31, 2013) is a low 14% of its market cap.

Moreover, even after these upgrades, CN should generate cash flow of $800 million to $900 million in 2013. That gives it plenty of room to keep buying back its shares. CN spent $365 million on share repurchases in the latest quarter.

CN also recently raised its quarterly dividend by 14.7%, to $0.43 a share from $0.375. The new annual rate of $1.72 yields 1.7%. This was the 17th time that CN has raised its dividend since it became a public company in 1995.

Profiting from recovering markets

CN’s 2013 earnings should rise to $6.13 a share, thanks to improving grain shipments following last year’s drought and rising lumber demand due to the recovering U.S. housing market. The stock trades at a reasonable 16.6 times that estimate. It also trades at just 14.8 times CN’s projected 2014 earnings of $6.90 a share.

CN Rail is a buy.