Dividend Impact of a Potential Acquisition for Norfolk Southern (NSC) Shareholders

One of the reasons why I love investing in dividend growth companies is that management has many tolls at their disposal to generate value for their shareholders.   The easiest manner is to announce a share buyback program or a dividend increase, which have minimal impact on the operations of the companies.  However, if management is looking for a larger splash, they can always spin-off a business unit, merge two companies out of no-where (See Kraft) or even sell the company to the highest bidder.   All of these scenarios have different impacts for us dividend growth investors.  Today, I wanted to take a look at one of the rumors that has been floating around for the last couple of weeks and analyze how the move would impact my forward dividend income.  Let’s dove into these Norfolk Southern (NSC) buyout rumors.

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The Situation & Offer

My journey and plunge into ownership began in the spring of 2015 after Lanny performed a stock analysis over the company, indicating the company was undervalued at the time.   I had some extra capital to spend and I initiated a position in the company.  What’s funny is the stock continued to fall in price as the market and commodities became less stable and I ended up buying the stock four different times, lowering my cost basis along the way.  In total, I own 27.64 shares of Norfolk Southern, which produces $65 in projected dividend income annually.   Just quickly, some of the things that drew me to NSC were the history of dividend increases, the high barriers of entry to the railroad industry, and the company continued to trade at a discount among its peers.  I’m still a little shocked that the company’s stock price fell below $75/shares this year and it seemed to take a larger beating than others in the industry.  However, I was fortunate to DRIP a few dividends at a lower price for an extended period of time.

A few weeks ago I checked my investing app and saw that NSC’s stock price shot up nearly 10%.  I was excited and thought that NSC had finally announced their annual dividend increase!   Wishful thinking, right?  As it turns out, several articles were published indicating Canadian Pacific’s interest in purchasing NSC.  So just like that I saw my long-term stream of dividend income turn into a short-term gain (if the merger is completed as discussed).  Over the last week, details have emerged regarding the current offer on the table.  From an article in Bloomberg this week,

“Canadian Pacific on Wednesday released the contents of its letter, confirming Norfolk Southern’s statement that the bid was $46.72 in cash and a fixed exchange ratio of 0.348 Canadian Pacific share based on Friday’s closing price. That indicates an offer of $94.02 a share for Norfolk Southern, 5.7 percent higher than its closing price on Friday. The bid amounts to about $28 billion, based on Norfolk Southern’s shares outstanding and the terms that Canadian Pacific laid out.”

The bid in its current form is a nearly 50/50 split between cash and CP stock.  There have even been grumblings that NSC has rejected the current bid and considered this a “low ball offer,” so I am sure there will be subsequent negotiations aim to increase the premium received by NSC shareholders.  I’m sure there will be plenty of news about this topic over the next month or so as talks progress and new details emerge 

Impact of Norfolk Southern Acquisition

Selfishly, I wanted to take at this acquisition and see how it would impact my portfolio and forward dividend income.   After all, owning 27 shares of Norfolk Southern represents a decent percentage of my portfolio and this acquisition could have major implications going forward.  Assuming the facts of the current offer, if accepted, I would receive $1,290 in cash and 9.619 shares of CP’s stock.  Currently, CP has an annual dividend of $1.07/share and the new position would net me $10.29 in annual forward dividend income annually.  I’m not exactly sure how I feel about this though.  On one hand, it would be nice to receive the cash without having to pay a trade fee and have the freedom to invest in other great dividend stocks.  There are plenty of great discounts available in the market right now such as HCP, which Lanny purchased recently, or some of the other stocks on our last watch list.  Unfortunately though, I wouldn’t receive the cash until the merger closes and due to the sizes of the companies, I don’t see this acquisition closing any time soon.

The second thought that popped into my head was “Do I even want to own shares of CP? Does it even fit my investment strategy?”  Answering this question is also key because I am losing one great dividend growth stock in my portfolio and would like to replace it with another.   Let’s take a quick look at CP’s dividend information and run the company through our stock screener.  CP’s yield is way below the average yield of the S&P 500, CP has a payout ratio of <20% and has a paid a dividend since 2001.  What concerns me about the company is that the dividend growth rate has been less than stellar over the last few years as the 3 and 5 year average dividend growth rate’s are 2.56% and 6.37%.  I understand a low growth rate with a higher yield, but I expect larger dividend increases from a company with that low of a yield.  This stock definitely would not classify as one of our Top 5 low dividend yield, high dividend growth rate stocks.

Based on my quick analysis, it does not seem like CP fits my investing strategy.    So where do I go from here?  If you recall, Lanny went through a similar dilemma when Lorillard  (LO) was purchased by Reynolds-American (RAI).  Ultimately, Lanny decided that RAI was not the best tobacco stock for his portfolio considering the loss of income that resulted from the acquisition and instead decided to sell before the merger was complete, take his gains, and invest the full amount in a different tobacco company he liked better…Philip Morris.  In hindsight, the move has worked out perfectly for him and he reminds me of this transaction on what feels like a daily basis.   His experience taught me a great lesson and I think I will deploy a similar strategy once a final agreement is reached and the full terms of the transaction are disclosed.  As I brainstorm quickly, here are the three courses of action I will most likely take.

  1. Buy a Different Railroad Stock- Clearly I enjoy owning a railroad company because of the high barrier of entries in the industry.  Otherwise I would never have bought NSC in the first place.  There are a few other names that offer a better dividend yield and dividend growth rate than CP, such as Union Pacific (UNP), CSX (CSX), or Kansas City Southern (KSC).  This strategy would be nice because I would not lose my industry allocation.
  2. Buy One of My 5 “Always Buy” Stocks – Earlier in the year I create a list of 5 stocks that I am always looking to buy.  These stocks were identified because of their strong dividend histories, economic moats, and successes over a long period of time.  If I am ever unsure of a purchase and need to make a quick investment decision, I turn to this list.  I wouldn’t mind buying another massive stake in a company like 3M or Johnson & Johnson with the funds from this acquisition.
  3. Buy Realty Income – Last week I performed a stock analysis over Realty Income and loved what I saw.  The company is a monthly dividend machine and is well diversified in the industry it operates.  I still can’t believe I don’t own this stock already.  Even though it may not be trading at a discount now or when the acquisition closes, I may use this transaction as an excuse to initiate a position and forget about the stock!

Summary

As I said earlier, we still have a long way to go in this as management as the two sides appear to be digging in their heels.  Who knows if the transaction will go materialize?  But if the transaction does occur and the structure of the deal is similar to the one disclosed above, I know what move I will make.  Look for a Sell article and a Buy article as I will sell my stake in Norfolk Southern prior to the merger, capture the gain, and re-deploy my capital elsewhere.  There are plenty of other great dividend paying companies out there!

What would you do if you were me?  Would you hold on to a stake in CP?  Or do you prefer a different railroad company?  Have you experienced a situation before where a company has been acquired and you do not want to own the new acquiring company’s stock?  How have you handled it?

-Bert

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9 thoughts on “Dividend Impact of a Potential Acquisition for Norfolk Southern (NSC) Shareholders

  1. Thank you for sharing your insights on the potential acquisition of NSC by CP. I would really like to own a railroad stock, but CP did not meet my criteria, and CNR was not trading at an attractive valuation when I was looking to add an industrial stock to my portfolio in October. If CP and NSC reach a deal, would you have time to sell before the completion date as Lanny did with RAI? If I were in your position, and CP acquired NSC, I would consider selling NSC, then re-investing half of the proceeds in options 1 and the other half in option 2. If O has an attractive valuation at the time of selling NSC, then I would put half into O instead of option 2. I’ve added O to my watchlist and will be watching for a good entry point.

    • Thanks for stopping by DN! I appreciate your insight on the situation. There will be plenty of time to complete the acquisition if it is ever announced. I can’t imagine this thing closing before the end of 2016 with all of the filings and details that will need to be ironed out. Option 2 is my favorite so far as I am itching to invest in Realty Income. The problem is that the company’s stock price just won’t stop increasing!

      Bert

  2. Thanks for the analysis on CP. It’s funny but I was thinking the exact same thing with my NSC shares.

    CP with its low yield and low dividend growth just doesn’t fit with my investment plan. If the merger actually happens I am definitely taking the cash and buying something else! I am thinking about one of the Canadian banks or a REIT…

    Take care.

    • Dividend Shooper,

      Thanks for stopping by and the comment. Glad to see that you and I are on the same page here. WE almost have the exact same strategy, just different REITs. The prospect of losing a great dividend growth stock upset me. But I guess there are plenty of other great ones for us to invest into, right? I guess the one thing that I didn’t really consider is that CP could potentially increase their dividend after the merger, especially considering that NSC is actually a larger company. Who knows? They could always adapt NSC’s dividend policy and throw a big curveball at us. My opinion would be much different if that were the case.

      Bert

  3. One additional factor for consideration: Will the combined entity ultimately meet (or exceed) your minimum criteria? With the current low payout ratio and the reports of Squires being offered the CEO position post merger, shareholder friendliness could be on the upswing.

    All the rails got a boost from this news which probably puts KSU outside your screening criteria as well. My guess is that KSU’s greatest value is as a target for CSX, CNI or even NSC.

    So you could take your profits off the table like Captain Dividend did with his PNY stake with the DUK merger but this approach has potential tax considerations.

    So my choice is to kick the can into the next tax year with both PNY and NSC. The CP stock portion I’ll probably retain as it should be a tax-free transaction (and I have an existing position). The cash portion – I’ll pay the tax and reinvest the proceeds based on the values available in the market at that time.

    • That’s a great point Charlie and one that I didn’t give the proper consideration. We don’t know any of the meaty details yet. How can they tell us the true forward dividend policy considering they haven’t even agreed on a merger. A lot can happen and you are absolutely right, they can definitely become more shareholder friendly. That’s the fun of it all though, right?

      The tax issue is a big deal and I unfortunately have to wait until next summer to avoid paying a long-term capital gain. I dig your strategy Pay as little taxes as possible. It’ll be hard to receive the cash lost from taxes in appreciate + dividends for a while.

      I appreciate your comment and it was very helpful. Regardless of the outcome, I’m glad NSC is showing some life and we are going to receive some benefit as a investors. Have a great evening.

      Bert

  4. It is a tough call on what to do. One note about CP – is that its been one of the best turnaround stories. The dividends are paltry, but the company has been working away on improving efficiency and turned that business around. Hunter Harrison is an ex-CEO of CN…and was brought out of retirement with a lucrative proposal from Bill Ackman. He is one of the best railroaders out there and he sure showed how things are done. The stock price has appreciated by leaps and bounds over the last 3-4 years and CP currently boasts one of the best margins in the industry right behind CN, beating out the great such as UNP. However, Harrison has health problems and is taking a sabbatical right now – and wont turn into a stepdown.

    R2R

    • R2R,

      Thanks for the insight on CP. No doubt the company has had an impressive streak and done a lot of great things recently. However, based on the current metrics, it just doesn’t fit my portfolio or investing strategy. I don’t want to take anything away from what they have accomplished…just not for me.

      I still want to see how this story ends. But if the deal resembles the structure that was announced, I will definitely sell and look elsewhere. Only time will tell!

      As always, thanks for stopping by!

      Bert

  5. I looked at UNP recently and really liked it. I saw it is currently trading at discount and it’s the kind of stock perfect for a core portfolio.

    Did you look at it? What did you think?

    Cheers!

    Mike

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