Q: Hello, a fund manager who is a frequent guest on BNN has mentioned more then once that his firm recently sold their CNR holdings after learning that the company had recently used debt to buy back shares. He failed to provide much detail as to why he did this and why he was not happy with managements decision to do this. From what I understand, companies will from time to time, buy back shares when they feel the shares are undervalued. Perhaps they secured a competitive rate on the debt and felt that buying back the shares was a constructive action to take with this new debt. Would you be comfortable buying CNR at these levels? Looking forward to your thoughts. Thanks.
5i Research Answer:
CNR pays a 2.55% dividend, which is paid with after-tax earnings. So, a buyback is less costly, even with debt, when one considers the tax-adjusted dividend savings. Debt interest is tax deductible, dividends are not. Considering CNR's very impressive long term shareholder value creation, we would be reluctant to question management's capital allocation decisions. The company is generating more than $3B in free cash flow annually. The share count has declined by more than 150 million shares in the past 10 years and this has provided good per-share earnings leverage. Debt has doubled in that ten years, but so have earnings. We would remain comfortable with the stock. It has some short-term tariff and economic risks, however.