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Bill Ackman’s New Project – Canadian Pacific Railway

December 09, 2011 | About:
Holly LaFon

Holly LaFon

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Investments Bill Ackman makes at his Pershing Square hedge fund are at the same time event driven, long-term focused and unconcerned with macro events. Though his third-quarter performance trailed the major market indexes, he hastened to add in his investor letter that the market value of the funds had recovered 11% since then. His quarterly report also revealed a 4,040,235 share investment in Canadian Pacific Railway Ltd. (CP). Shortly thereafter, on Oct. 28 and Nov. 22, activist 13Ds revealed that he had heaped on large amounts of shares to bring his total to 21,057,428, or 12.4% of the company’s shares outstanding. While the company has underperformed its closest competitor Canadian National Railway Co. (CNI), Ackman believes the discrepancy is not connected to “structural factors” at the company. Among the six Class I North American railroads, Ackman sees in Canadian Pacific potential for increased value if he can fix the problems therein.

Canadian Pacific Railway is a company on the mend from a downturn in 2009. That year, the railroad’s traffic fell to unprecedented low volumes. Management responded by issuing new equity and debt tenders, monetizing non-strategic assets, as well as making a $500 million prepayment to its benefit pension plans. It also reduced operating expenses by 17% to match its decrease in revenue of 18%, which meant storing locomotives and railcars, implementing new technology that reduced locomotive fuel costs, and laying off about 2,700 employees.

In spite of it all, CP pursued investments that can take 10-30 years to pay off, such as proposed growth projects in intermodal facilities in Edmonton, Montreal and Alberta.

Ackman appears to have entered the picture at a time when management is already aggressively tackling problems and financial measures have begun to respond. From 2007 to 2010, freight revenue from 2008 to 2009 fell from $5.4 billion to $4.4 billion. Then, from 2009 to 2010, it increased 13.2% to $5 billion. Revenue from almost all shipping products (coal, forest, automotive, etc.) followed the same pattern, except for grain, which was higher in 2010 than 2008. Earnings per share from 2007 to 2010 decreased 34%, while operating expenses increased 7.5%.

To promote growth in the long term, management has implemented a new strategy requiring significant capital expenditures. It will upgrade and install new sidetrack to support increased train length in 2012, then, in 2013, it plans to increase train length by 11% on its trans-Canada rail routes to increase efficiency. It has also bought into service 61 new high horse power locomotives to modernize its slower locomotives. The new trains will increase capacity, enhance service reliability, reduce emissions, further its long train strategy and contribute to its 1-2% annual fuel efficiency improvement target. A portion of its existing slower locomotive fleet will receive a revamp for further efficiency.

A continued increase in railroad fuel prices could affect the success of the innovations in upcoming years though. Prices increased 40.5% from August 2010 to August 2011.

Ackman noted in his investor letter that Canadian Pacific lagged its biggest competitor, Canadian National Railway (CNI), in almost every operating measure. Canadian National is a North American rail company with 20,500 miles of track, slightly larger than Canadian Pacific’s 14,800 miles. By contrast, CNI has increased its revenue an average 19% over the last 10 years, while Canadian Pacific’s rate was 5.5%. According to CNI’s company overview, it plans to foster growth primarily through quality service and deeper customer engagement, driven by disciplined execution and solid capital investments. CNI also had an operating ratio of 63.6% at year-end 2010, while CP was at 77%, with a goal of pushing it down to the low 70s in the next three to four years.

CNI’s manages based on a core “Precision Railroading” plan that encourages the company to run regularly scheduled trains that leave at predetermined times, with a specific trip plan that fits into the design of the train schedule. “As a result,” the company says, “the discipline to make things run like clockwork permeates the entire CNI organization.” It also says the plan “Precision Railroading enables better service, reduced inventory and capital requirements, reduced need for private fleets, and better cost competitiveness.” It has many plans to take “Precision Railroading” to the “next level” through many new initiatives.

If Ackman is successful with his negotiations with the company and his changes work, he could stand to make a significant profit from the company that makes up 3.2% of his concentrated portfolio. See more of Bill Ackman’s stock holdings here.


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