Canada is being home to one of the hottest transport debates seen in the last decade. Surprisingly enough it is far from legislating over auto pilots, bio fuels or frisking. The focus of Bill C-30, according to the Calgary Herald, is “federal legislation aimed at getting more grain moving on the rails.” Canadian Pacific (CP)’s chief operating officer Keith Creel told a House of Commons committee, however, that he had a great concern over the bill’s real effect. Company representatives argue that giving shippers the ability to transfer traffic to alternate railways may indeed slow down the grain supply chain due to increased handlings.
Canadian National (NYSE:CNI), the other railroad operator, has shown some opposition to the bill, arguing that the root problem lies in grain elevators. The debate comes at a crucial time for the industry, given an extremely harsh winter while having to move a record wheat harvest. Whatever the case, Bill Ackman (Trades, Portfolio) has been dropping Canadian Pacific throughout 2013, giving prospective investors an opportunity to pick it up. But should you?
Performance and Rewards
During fiscal year 2013, Canadian Pacific revenues grew by 8% while operating income doubled and free cash increased 470%. “The transformational pace of change at CP has definitely exceeded expectations,” said E. Hunter Harrison, chief executive officer. Most importantly, the same representative anticipated stronger results for the upcoming year. And that is the reason why Ackman’s decision is all the more trivial.
At the end of March, Canadian Pacific announced the purchase of 1,300,000 shares of common stock. The decision is a confirmation of the effort by the company to create value for shareholders. For the current year, 5,270,374 shares of common stock are expected to be repurchased, without exceeding 1,756,791 common shares at a time. If looking back, purchases have had a positive impact on stock value as it rose by $40 during the last year alone, or $80 in the last two years, on average.
For 2014, Canadian Pacific posted an expected scenario for growth to be reached. Worth highlighting are fuel cost, tax rate, exchange rate, pension costs and capital expenditure. Should the expected context materialize, management expects to claim a revenue growth of 6% to 7%, operating ratio of 65%, and 30% higher diluted earnings per share. Most importantly, capital investments are already on the way through the expansion of its receiving yard to the north and east of Pig's Eye Lake in St. Paul.
What Are the Indicators for a Positive 2014?
A negative sign for all rail operators is new government legislation, requiring companies shipping crude oil by rail to carry enough liability insurance to make up for shortfalls in coverage carried by railways. The measure has potential to raise fuel costs, modifying the economic context expected by Canadian Pacific. However, should fuels be impacted, it is expected to be greatly offset by the higher demand for railroad transport. Keep in mind the wheat harvest will not be completely transported this year.
Canadian Pacific’s operations are characterized by volume addition, safety and efficiency. That should keep the company away from disaster and profiting. Additionally, the company is focused on improving network capabilities by consolidating and repairing facilities to operate longer and heavier trains, and achieve higher car velocity as well as deliver on-time performance.
Coal demand is expected to remain a significant driver for Canadian Pacific, and long-haul U.S. metallurgical coal will replace short-haul thermal coal. Additional growth will be driven by demand in the oil and gas market. Management projects a normal performance of the automobile industry, pushing for mid-single digit growth.
Canadian Pacific currently trades at 32.8 times its trailing earnings, carrying a 71% premium to the industry average. Given the strong financial sheet and share value creating policies, it is recommendable to keep an eye on the company for a better entry point.
Disclosure: Vanina Egea holds no position in any of the mentioned stocks.