Tracking the Rails: How Canadian Railroads Navigate Trade Shifts and Reward Investors

The Canadian rail sector is at a crossroads. While UBS's recent Q2 analysis highlights near-term headwinds from tariffs, operational bottlenecks, and sector-specific risks, the broader narrative of North American trade recovery—and the railroads' role in it—offers a compelling case for long-term investors. For Canadian National Railway (CN) and Canadian Pacific (CP), the path forward hinges on leveraging grain export booms, energy sector resilience, and cross-border efficiency gains. Here's why the rails remain underappreciated plays in the supply chain renaissance.

UBS's Q2 Outlook: Navigating the Storm

UBS's cautious adjustments to CN and CP's financial forecasts reflect immediate challenges. The firm slashed CN's 2025 EPS estimate by 4% to CAD$7.50 and CP's by 5.6% to CAD$4.58, citing tariff risks tied to USMCA compliance and operational pressures like Vancouver corridor congestion. CN's Q2 EPS of CAD$1.84, missing consensus by a penny, underscored these hurdles.

But the bigger picture is more nuanced. While U.S. retaliatory tariffs on non-compliant automotive imports (a sector representing 50% of cross-border rail revenue) could shrink volumes by 50%, the railroads are not passive victims. Cross-border exposure is a double-edged sword: stricter compliance rules could reduce tariff risks over time, rewarding operators that prioritize USMCA-certified cargo.

Strategic Opportunities: Grain, Energy, and Cross-Border Smarts

1. Grain's Golden Harvest:
   National Bank Financial's upgrade of CN to “Outperform” signals confidence in a strong 2025 grain harvest. With Canadian wheat and canola exports forecast to surge, railroads stand to gain. CN's 20,000-mile network, linking prairie farms to Pacific ports, positions it as the go-to logistics partner. UBS estimates CN could still achieve 10% annual EPS growth if grain volumes meet expectations.

2. Energy's Mixed Signals:
   While UBS trimmed energy/chemicals volume projections due to macroeconomic uncertainty, Canadian railroads are not wholly dependent on oil. Diversification into renewables (e.g., wind turbine components) and petrochemicals could soften the blow. CP's Midwest-U.S. route, less tied to volatile oil prices, might offer a competitive edge here.

3. Cross-Border Efficiency as a Competitive Weapon:
   Mexico's rapid USMCA compliance has reduced its tariff exposure, but Canada's rail operators can counterbalance this by optimizing cross-border routes and cargo mixes. CN's recent focus on Gulf Coast connections—a key U.S. energy export hub—could redirect traffic away from tariff-heavy corridors. Meanwhile, automation and AI-driven scheduling (already in pilot phases) aim to cut congestion costs, a critical step after Q2's crew shortages and fuel surcharge declines.

Valuation Gaps and Regulatory Tailwinds

CN's stock trades at 20.2x forward EPS, below its five-year average of 22.2x. This discount reflects near-term risks but overlooks two critical factors:
- Regulatory Tailwinds: USMCA compliance, while a short-term drag, could become a long-term advantage. Railroads that partner with shippers to meet certification requirements may capture premium freight rates.
- Resilience to Volatility: Unlike cyclical sectors, railroads thrive on essential goods. Even if automotive volumes drop, grain and industrial shipments act as stabilizers.

Investors should also note CN's fair-value estimate of USD$0.33 (vs. a recent close of $0.31), suggesting modest upside. CP, while facing similar headwinds, has a narrower margin of safety given its smaller scale and higher exposure to automotive.

Investment Thesis: Buy CN, Monitor CP

The rails are not without risks, but their structural role in North America's trade recovery makes them a buy-and-hold opportunity. Key catalysts include:
- A bumper grain harvest in H2 2025.
- Regulatory clarity on USMCA compliance and cross-border tariffs.
- CN's operational turnaround, with a target to reduce its operating ratio below 60% by 2026.

Final Takeaway

Canadian railroads are at a pivotal moment. While tariffs and congestion cloud the near term, their networks are uniquely positioned to capitalize on North America's trade rebound. For investors willing to look beyond the Q2 hiccups, CN emerges as the safer bet—its scale, diversification, and undervalued stock offering a margin of safety. CP, meanwhile, requires closer scrutiny of its automotive exposure. In a world where supply chains are the new battleground, the rails are far from losers—they're just waiting for the right conditions to roar back.

Investment recommendation: Consider a gradual buildup in CN shares, targeting dips below CAD$170. Avoid CP until clarity on U.S. automotive tariffs emerges.