Canadian Pacific (NYSE:CP)
CP reported its third quarter results in late October. The rail environment is weak in light of developments in global commodity markets, yet results came in largely in- line with consensus. On the quarterly conference call, Hunter Harrison expressed confidence in the potential for further cost and capital expenditure reductions.
CP quarterly results showed revenue growth of 2% and the Company’s operating ratio (OR) improved 290 bps by declining to 59.9%. Net income increased 7% while EPS grew 16% as the company’s share repurchase program reduced shares outstanding. During the third quarter, CP bought back 5% of its shares as it continued to take advantage of the company’s low share price.
CP has increased its asset productivity substantially which, along with weakening commodity markets and lower volumes, has allowed the company to remove from service 15% of its rolling stock and 40% of its high power locomotives. Hunter commented that CP will not need to purchase locomotives until 2018, implying a seven-year purchase deferral since he arrived as CEO. This is better than management’s original estimates of three to four years, as the team has continued to improve locomotive productivity. These improvements are yet another illustration of the power of Hunter’s operating model and its impact on asset utilization.
Year-over- year, headcount is down through continued attrition of the workforce. CP recently reached an hourly rate agreement with its U.S. union, which should enhance efficiency. Hunter has predicted that a similar agreement could eventually be reached in Canada. Hunter remains optimistic despite current economic headwinds, explaining that CP is operating well, and that when growth picks up “we’re going to have to buy a bigger safe for the funds.”
CN announced a 53.8% OR in the third quarter, by far an industry record, highlighting the substantial opportunity ahead for CP. Hunter said he thinks CP’s OR should be 200 to 300 bps lower, even at existing volume levels. He also stated that capital expenditures would begin to come down in the coming years, as the Company has caught up to previous management’s underinvestment in the network. Given the increased efficiencies to come, the Company said it was confident in generating double-digit EPS growth next year despite the softer macroeconomic backdrop.
The CP-Norfolk Southern Merger
CP has proposed a merger with Norfolk Southern (NS), which would create significant value for both CP and NS shareholders. As importantly, CP’s proposed merger with NS would provide unsurpassed levels of safety and service to its customers and communities while also increasing competition and creating significant shareholder value. When one owns a company run by extremely able management, it almost always makes sense to get additional assets under their management if the new assets can be acquired at a fair price.
On December 8th, we participated on a conference call CP hosted to discuss the transaction, and outlined an investor’s perspective on the attractiveness of the CP offer to NS. We believe CP has put forth a highly attractive offer to NS shareholders. We estimate the offer to be worth $125 to $140 per NS share at the time of the closing of the transaction in May 2016, representing a 58% to 77% premium to NS’s undisturbed share price, a meaningfully higher value than NS could achieve as a standalone entity. For more details on the CP proposal, we encourage you to review management’s and our presentation. Please contact CP investor relations or go to www.cpr.ca for further information.
From Bill Ackman (Trades, Portfolio)'s Pershing Square Holdings third quarter 2015 letter to shareholders.
