Bill Ackman to Trim Largest Holding Canadian Pacific Railway - History and Analysis
Ackman’s firm said it would sell 7 million shares over the next six to 12 months. The sell would decrease his position size from 24,159,888 shares to 17,159,888. At Tuesday’s trading price of $127.97, the transaction would be worth about $895.79 million, almost earning back his $1 billion he paid for the stake in 2011.
Ackman said he would reduce the holding, his largest with 31.3% of the portfolio, because it takes up too much space.
It is also good timing for a sizable profit: “Thanks to Hunter Harrison’s and the CP team’s performance over the last nearly one year, Canadian Pacific’s share price has more than tripled since we first invested in CP,” he said in a statement.
Ackman purchased CP when it was not particularly undervalued, and his activism in the company’s operations may have greatly affected the price. In the fourth quarter of 2012, it had a P/E ratio between 16 and 21, at the higher end of its five-year historical range.
Its P/S and P/B ratio fell to multi-year lows at the outset of the fourth quarter, and returned to their previous levels by quarter-end:
The Peter Lynch chart also indicates that the stock was not undervalued at the time Ackman purchased, and he could have made a higher profit by investing earlier when it was, in 2008 through 2010. That the green price line is so much higher than the blue P/E line also signals that now is not a good time for investors to buy CP:
The GuruFocus Reverse DCF calculator also shows that at a share price of $121.60, investors expect the company to grow 24.6% annually for the next 10 years. Such a rapid pace is highly unlikely for a railroad company.
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In the past 10 years, CP grew revenue per share at a rate of 2.9% annually, and EBITDA per share at a rate of 1.9% annually on average.
The company is also trading near its 10-year historical high P/E, P/B and P/S ratios, as seen in the charts above.
Ackman’s changes in the company’s operations may have long-lasting effects on the CP, however. Early on, Ackman asserted that the company’s core problems was inefficient asset utilization and productivity leading to operating margins at half of its Canadian competitor, rather than a need to boost revenue, he said in his June 2012 letter to investors.
In the third quarter of 2011, when Ackman launched his activist campaign, CP had increased its revenues by $55.4 million to $1.3 billion. Net income, on the other hand, had declined by $10.5 million to $186.8 million, and operating margin had declined to 24.2%, with an annual operating margin of 18.7%, its lowest level since 2004.
Its operating ratio – which railroads use to demonstrate the percentage of revenues used to operate the railway by dividing operating expenses by revenues – reached 75.8%. The railway attributed the higher ratio to the weather and higher costs for fuel, crew training and IT.
After several quarters of Ackman’s cutbacks, CP announced its “best first quarter results in its history.” Revenue increased 9% to $1.495 billion, and net income increased to $217 million, from $142 million. Operating margin was 24.2%, from 19.9% the previous year.
The operating ratio was the same, at 75.8%, but a 430 basis point increase from first quarter 2012. The company’s plan is to lower the figure to the mid-60s by 2016.
CP’s three-year revenue, earnings and price history chart:
The company in May also moved up a $1.1 billion capital investment program from 2014 to 2013, and increased its size, due to higher-than-anticipated cash flow projections for 2013. The key parts of the program are to upgrade a line, upgrade a signaling system and acquire core assets it otherwise would lease, with the aim of boosting productivity, safety and efficiency.
Having gotten seven of his board nominees and himself elected to CP’s board in May 2012 and replacing the CEO with his pick, former Canadian National Railway (CNI) CEO Hunter Harrison, means Ackman’s agenda will likely continue to go forward.
Ackman affirmed in the release that his influence at the company would continue after the sales by saying he and one of his Pershing Square colleagues would continue to sit on the board. “Even after these sales, we expect to remain CP’s largest shareholder and for CP to remain one of our largest investments,” he added.
Read a short case on CP.
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