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Rail Stock's Steep Uptrend Could Result in a 12%-Plus Gains

According to the Oracle of Omaha, Warren Buffett, American prosperity in part depends on "an efficient and well-maintained rail system."

Railroads carry raw materials to factories and finished goods to consumers, and as vital as they are to the U.S., their importance goes far beyond America. Globally, more than 73 million people and over 70% of all goods are transported by rail each year. That number is expected to grow as the world and American economies strengthen.

According to the U.S. Department of Transportation, rail freight demand is expected to surge 90% by 2035. New track is being laid and facilities, terminals and tunnels built to prepare for the "resurrection of the railroad."

International rail giant Canadian National Railway Company (NYSE: CNI) should be one of the major beneficiaries of this trend.

As Canada's largest rail company -- based on revenue and rail network size -- CNI owns over 20,000 miles of track spanning Canada and mid-America. CNI transports about $250 billion worth of goods a year, ranging from petroleum and chemicals to grains and fertilizers to metals and minerals.

Revenue is expected to grow in the coming years based on strength in the North American economy. In CNI's most recently reported third quarter, higher freight volumes, strength in the energy market, positive currency transactions and higher fuel surcharges helped the company achieve record quarterly sales. Q3 revenue increased 8% from the comparable year-earlier period to $2.6 million. Earnings for the quarter rose 13% from the year-ago period to $1.66 per share.

With continued increase in demand for freight hauling, Standard and Poor's recently raised its price target for CNI from $115 to $125, citing accelerating volume growth.

From a technical perspective, the $125 price target certainly appears achievable.

CNI Stock Chart

Rising off a December 2011 low under $70, shares formed a major uptrend, gaining over 60% to date.

In February, the stock peaked near $103. Shares then retreated, falling to a low near $93 in April. Rising off this low, the stock tested the $100 range again in May, reaching a new high around $103.50. However, unable to sustain momentum, shares faltered once again, falling just below $93 support in June.

Gathering momentum again, the stock retested resistance near $100 in July, but yet again lost steam, falling to exactly $93 support by mid-August. The technical formation, therefore, was a rectangle with three peaks and three valleys.

After bottoming at $93 for the third time, shares surged, punching through resistance near $103. Since that time, CNI has been in an accelerated uptrend.

This month, shares stalled around $111, marking a current shelf of resistance. They are currently trading just below the all-time high of $112.27 made on Nov. 4.

If the stock can definitively break resistance near $111, shares could again surge since there would be no overhead resistance. S&P analysts project shares could reach $125. At present, this target presents traders with 12% potential returns. However, with no resistance, shares could move much higher.

The bullish technical outlook is backed by strong fundamentals.

For the upcoming fourth quarter, analysts project higher freight volumes, based on strong crude oil shipments, will push revenue almost 9% higher to $2.75 billion from $2.53 billion in the comparable year-earlier quarter.

For the full 2013 year, analysts expect economic growth in North America will translate into 7% revenue growth with sales reaching $10.59 billion from $9.92 billion last year.

The earnings outlook is similarly solid.

For the upcoming fourth quarter, analysts project freight rate increases will help earnings rise 16% to $1.64 per share from $1.41 in the year-earlier quarter. Higher fuel surcharges should help full-year 2013 earnings increase nearly 11% to $6.21 per share from $5.61 last year.

One sign of CNI's financial strength is the company recently announced plans to repurchase up to 15 million shares. Management also announced a 2-for-1 stock split that will take the form of a stock dividend. Shareholders on record as of Nov. 15 will receive one additional share for each share held on Nov. 29.

Currently, the stock offers an annual yield of about 1.5% (on pre-split prices). Every year since 2002, the annual dividend has increased, rising from $0.28 per share in 2002 to $1.62 currently. Given increasing revenue and earnings, the company is likely to increase the dividend in the future.

Risks to consider: Freight shipment volumes correlate strongly with GDP and could decrease if there is an economic slowdown. However, with higher-than-expected GDP growth reported Thursday, this risk appears minimal in the short term. 

Recommended Trade Setup:

-- Buy CNI above current resistance at $111.40
-- Set stop-loss at $101.91, just below current support
-- Set initial price target at $124.99 for a potential 12% gain by mid-2014