Contributing editor Tom Slee is back with us today, tanned and refreshed from a Caribbean cruise. Being on board a ship got him thinking about transportation stocks and their influence on the overall market trend. Some of his conclusions may surprise you. Here is his report.
Tom Slee writes:
One of the first things I learned in this business was to keep an eye on the Dow Jones Transportation Index (DJTI). Often referred to as the "Canary in the Coalmine", it's one of the few worthwhile market indicators. As Charles Dow himself discovered, no upward movement in the Dow Industrials is sustainable unless confirmed by the DJTI and for good reason. The two indexes are correlated; dependant on each other. As the traders say, one "makes", one "takes" and the relationship holds true even in these modern times. The Dow Jones Transportation Index has led every major rally since 2004. So despite the recent choppy markets I remain very encouraged. As of Friday's close, the DJTI is up a solid 6.7% since Jan. 1, while the Dow Industrials is ahead a meager 3%. Our canary is alive and well.
I am not for a moment suggesting that the market is going to take off just because one index is sending the right signals. There are, however, some good fundamentals supporting the DJTI's strength that bode well for stocks generally. The railway industry, which forms a large part of the Transportation Index, has weathered the downturn surprisingly well. Traffic was certainly down but the companies not only maintained their rates but made increases stick. It was a remarkable achievement during the worst recession since the Second World War. Trucking firms, by contrast, were slashing prices to stay alive. Moreover, most of the Class 1 rails have used the last two years to pare expenses and are now sitting on substantial cash balances. They are already benefitting from the upturn.
That having been said, there is a limit to cost cutting and this year any meaningful improvement in earnings growth depends on increased revenues. We need top-line growth and although there are some encouraging signs the prospects for business are mixed. Some forecasters are extremely cautious. Standard & Poor's recently published an analysis that remains "neutral" about railroads. There is concern about the huge stockpiles of coal that utilities were building towards the end of last year. These will dampen shipments in 2010.
Personally, I am much more optimistic about the railway companies. My feeling is that the buoyant Dow Jones Transportation Index has got it right. There are several reasons for this optimism.
First, we have seen a steady improvement in the shipment numbers for the last six months and there is increasing momentum. Demand for potash is finally picking up and the Canadian Wheat Board recently increased its export projections by two million tons to the highest level in 10 years. NAFTA surface traffic has grown for six consecutive months. So there is no need for a sudden turnaround, just a continuation of the present trends.
I also think that the cautious 2010 shipment forecasts issued by several of the railways are too pessimistic. You can understand why. CEOs, still licking their wounds from 2009, are inclined to aim low and hopefully surprise shareholders by beating the forecasts. The customers, on the other hand, are expecting a lot of activity. A survey released by the Canadian Institute of Traffic and Transportation in late December showed that shippers are calling for an 8% increase in volumes this year. In addition, they believe that core freight rates will rise 2% in 2010. If that outlook is reasonably accurate, and keep in mind that these are the people paying the bills, we should see something like a 10% growth in railway industry revenues this year.
In turn, because the companies have been shedding overhead, a lot of this income will flow to their bottom lines and improve the operating ratios (the percentage of sales needed to run the railway). Any pick-up in the economy will also help. Business inventories are low and even a slight increase in demand will spur shipments, especially intermodal loadings where rails have a big edge over trucks.
All of this points to much better earnings in 2010 than analysts are expecting. In fact, the numbers may be much higher and I am bullish on the stocks, especially as they are still relatively cheap. At the moment, CN Railway is trading at less than 15 times this year's forecasted earnings. Union Pacific also has a 15 P/E multiple, well below the 17 times we can expect in the railway sector during a recovery.
The fact that the threat of new regulations has receded is another plus. For several years now shippers have been complaining to Congress about freight rate hikes and demanding regulatory relief. The Surface Transportation Board actually decided against the rails in several rate cases in 2009. Now though, it looks as though Congress is losing its appetite for more controls. As Gordon discovered at the recent World Money Show in Florida, many Americans want government to butt out. As a result, it's likely that several pending railway rate bills will be allowed to die on the order papers.
Another plus is that investors are beginning to realize that the new Panama Canal expansion will not siphon off a lot of railway traffic from the west coast ports, at least not for five or six years. The new lock capacity will not be ready until 2014 at the earliest. Even then Asian shippers are going to assess the new facility before redirecting their Eastern Seaboard traffic. Moreover, there is already talk of higher canal tolls and the aggressive railways are going to respond to the new competition.
Turning to the railway companies themselves, Canadian Pacific (TSX, NYSE: CP) has the most potential but also the most unpredictable earnings. Take the company's fourth-quarter performance for example. At first glance, the numbers were encouraging. Operating profit came in 94c a share, well above the 89c consensus. Operating expenses were down 17% year-over-year and this partially offset a 16% drop in revenues. As a result, and assuming strong grain shipments during the first half of 2010, CP should make about $3.35 a share this year and $3.90 in 2011. CEO Fred Green, however, lost no time in dampening expectations. He told analysts that he sees little cause for optimism and spoke about a "difficult" prolonged period. It was a somber message.
Part of the problem, I suspect, is that CP is now facing some fundamental difficulties. The company is going to need significant levels of capital spending in order to upgrade and expand its network. Rising taxes and increased pension contributions also loom. There is going to be a substantial cash drain. To make matters worse, CP has become engaged in a serious pricing dispute with Teck Resources, its largest coal customer. Presumably Mr. Green will resolve this but it's a public relations disaster and makes investors uneasy.
So that there is no misunderstanding, I still think that Canadian Pacific Railway will do relatively well in 2010. The Street's target for the stock is through $60 and it is currently trading at C$55.10, US$54.24. But given the choice between Canada's two major railroads, I much prefer CN. In the U.S., I like Norfolk Southern. Both have fewer question marks and both are already on our Buy list. See my updates for complete details.
Finally, here is a quick note about the Canadian banks' first-quarter results. In short, they were excellent! Overall industry earnings were almost 10% above expectations and analysts are scrambling to upgrade their 2010 earnings estimates. I will provide a more detailed update next time, but I am moving our target on TD Bank up to $82 immediately. The shares closed on Friday at C$74.70, US$73.51.
TOM SLEE'S UPDATES
CN Railway (TSX: CNR, NYSE: CNI)
Originally recommended on May 6/02 (IWB #2218) at C$25.95 (split-adjusted). Closed Friday at C$59.99, US$58.88.
CN reported a fourth-quarter profit of 90c a share, in line with the 91c consensus estimate. The good news was that the company also announced an increase in the quarterly dividend to 27c and a 15 million share repurchase program (3.2% of the float). It was a display of strength and confidence that few Canadian companies could match right now.
Looking ahead, CN should benefit from increased grain exports and record U.S. corn and soybean crops. Heavy capital investments over the last few years are also expected to start paying off, especially at the Memphis yard and in Prince Rupert, B.C. The company hopes to capture another 1% of the North American container market. You get the feeling of a company on the move, with or without a strong business recovery. At the same time, the balance sheet remains strong and the free cash flow in 2009, a difficult year, was close to $800 million.
Earnings of $3.90 a share are expected in 2010 with an increase to $4.50 next year.
Action now: CN Railway is a Buy with a target of $65. I have set a $50 revisit level.
Norfolk Southern Corp. (NYSE: NSC)
Originally recommended on Dec. 14/09 (IWB #2944) at $52.22. Closed Friday at $55.33. (All figures in U.S. dollars.)
South of the border, Norfolk Southern racked up a fourth-quarter profit of 82c a share, close to the 84c Wall Street was expecting. The numbers were solid across the board with coal shipments particularly strong. Most important, Norfolk was able to maintain its third-quarter top-line momentum.
Nearly all of the medium-term trends in NSC's markets remain favourable. Norfolk has a strong intermodal franchise in an area where hard-pressed trucking companies are being forced to raise rates. That gives management the happy choice of either raising rates as well or grabbing market share. The outlook for metallurgical coal is improving and NSC is well positioned along Eastern Seaboard to service China's growing need.
What I particularly like about Norfolk is its diverse customer base, strong balance sheet, and relatively low 73.9% operating ratio. This is a railroad that can continue to make money even if the recovery is stalled. Assuming at least some modest improvement in demand this year, NSC should make about $3.75 a share in 2010 followed by $4.50 or more in 2011.
Action now: Buy Norfolk Southern with a target of $62. I will revisit the stock if it drops to $45.
Bombardier (TSX: BBD.B)
Originally recommended on Oct. 19/09 (IWB #2937) at $5.03. Closed Friday at $5.87.
Turning to another sector, Bombardier had a good third quarter, reporting earnings of 10c a share (the company reports in U.S. dollars), slightly above the 9c consensus estimate. Revenues of $4.6 billion were flat year-over-year and the company's all-important operating margin came in at a respectable 9.5% with a strong Transportation division more than offsetting the relatively weak Aerospace segment. On balance, given the tough business jet market, it was a respectable performance.
What I find encouraging about Bombardier is that the company is slowly but surely becoming better balanced. Management is building a solid, reliable Transportation base under its volatile Aerospace business. Trains now account for about 55% of sales and 62% of BBD's $47.4 billion backlog. That may take away some of the stock's glamour but it does make things much more comfortable and predictable for long-term investors. It's also the reason that I now regard BBD as a growth stock with trading opportunities as a bonus.
Not that I am despondent about the aerospace markets. In February, the company announced that it had delivered 176 business aircraft as well as 121 commercial and five amphibious aircraft in fiscal 2010 (the company's year- end is Jan. 31). There was a modest improvement in new orders during the period and there are now indications that the jet market bottomed in the second half of last year.
The big news, though, is that Bombardier has finally bagged a big North American order for its CSeries airliner. A few weeks ago, CEO Pierre Beaudoin announced that the company had signed a contract with Republic Airways for 40 of its new CS300 model along with an option for 40 more. This is a real breakthrough and not only almost doubles the European orders for CS planes already on the books but also provides an incentive for other American airlines to jump in and buy. Incidentally, the CS300 can be configured to seat as many as 149 passengers and propels BBD into direct competition with Boeing and Airbus. For now, though, these giants have no comparable medium-sized plane in this 6,000 aircraft market. Bombardier has a great opportunity to make some inroads.
A word of warning: because of it its exciting aerospace exposure, BBD is a media darling and good as well as bad news is often blown out of proportion. As a result, the stock is jerked around. It's not for the fainthearted. However, the numbers are improving and the prospects look brighter.
Action now: Bombardier remains a Buy with an increased target of $6.75. I will revisit the stock if it drops to $5.
Potash Corporation of Saskatchewan (TSX, NYSE: POT)
Originally recommended on Jan. 28/08 (IWB #2804) at C$133.98, US$132.74. Closed Friday at C$123, US$121.16.
Over at Potash Corp., the recent fourth-quarter results were less encouraging. POT earned 80c a share (the company reports in U.S. dollars) but that included a gain of 9c from foreign exchange. Operating income was 71c a share, well below the 79c Bay Street had been expecting. Margins were squeezed by weak offshore sales and higher energy costs.
This stock, as you know, is really a play on world-wide demand for fertilizer. As a matter of fact, the company accounts for 20% of the global markets. It's a one-commodity player, which is fine except that short-term demand for potash is extremely difficult to forecast. Prices are not directly related to economic trends. They depend to a large extent on unpredictable climate conditions and crop yields.
As a result, POT's earnings are volatile. For instance, in 2008 things were booming and at one stage potash, which some experts believe can be mined and marketed for US$70 a ton, was priced as high as US$1,000 in some countries. Potash Corp. earned an impressive $11.05 a share. Then last year the grain markets collapsed and farmers slashed their expensive fertilizer purchases. They preferred to skimp. Potash prices plummeted and POT made a paltry $3.25 a share.
Demand has picked up a little recently but only in fits and starts; on a contract by contract basis. As recently as February, Israel Chemicals was selling potash at US$355 a ton to China, although POT refused to do a deal at that level. The outlook is mixed. That is why CEO Bill Doyle's announcement on March 12 that Potash is going to earn as much as $1.50 a share in the first quarter surprised the market. POT jumped 6.5% to almost $128. There was talk of resurgent potash markets. It seemed almost too good to be true.
Now that they have had time to mull over the news, some analysts are a little puzzled. Mr. Doyle, who should certainly know, spoke in terms of a "kick- start rebound" in prices but there is little evidence of this. Farmers have been cautiously restocking but as the recent contracts showed, there is no buying wave. I would also like to point out that while the improved guidance is welcome, it's hardly a bonanza for POT.
Given the hard numbers available, an average price for potash in the US$450 range this year seems to make sense. Using this forecast, POT should make about $5 a share in 2010. With the stock trading at $123 that means it has a price-to-earnings ratio of 24.6. Even straight lining Mr. Doyle's new guidance, a dangerous idea in the potash business, we have a 21 P/E multiple. So the stock is fully priced at the moment. By the way, for this purpose I have assumed a Canadian dollar at par.
Nobody seriously doubts that the long-term outlook for potash is solid. There are 6.6 billion people on the planet and that number is expected to climb to 8.2 billion by 2030. In addition, many people are eating a great deal more. We are going to need a lot more food and a great deal of fertilizer.
Nevertheless, I think that we will have to wait until 2011 or even 2012 for a significant increase in POT's earnings. Also, there are several recent developments that concern me. Brazilian mining giant VALE has acquired Bunge's phosphate operations for US$3.8 billion and BHP Billiton has purchased Athabasca Potash. As a result, there are now two new huge, well-heeled competitors in the potash business. In addition, there are reports of poor corn yields.
On balance then, I think that Potash becomes a Sell at the current level for investors who want to take advantage of the price spike and use the money elsewhere. For those able to take a long-term view, the stock remains a Hold, at least until we see the second-quarter results.
Action now: Potash Corporation is a Hold for long-term investors. Short-term traders should sell. I will continue to monitor the stock.
Enbridge Inc. (TSX, NYSE: ENB)
Originally recommended on Aug. 23/99 (IWB #9930) at C$16. Closed Friday at C$48.48, US$47.74.
Enbridge, as expected, delivered a solid fourth quarter. Earnings came in at $300 million or 81c a share compared to $264 million or 72c a share the year before. After adjustment for special items, the company made 65c a share, in line with expectations. Earnings of $2.37 a share for the year were slightly above management's $2.30 - $2.36 guidance range.
Those are impressive numbers and they are only part of the story. Enbridge also revealed that new projects are being brought into service while others are on time as well as on budget. Management announced ahead of the earnings that it has entered into leases with Statoil to transport 30,000 barrels of bitumen a day from the oil sands. The arrangement is expected to grow to 220,000 barrels a day and provide additional pipeline expansion opportunities. Later this year, the Alberta Clipper line between Alberta and Wisconsin and the Southern Lights line, designed to transport light oil from Chicago to the oil sands, are both scheduled to commence operations. I could go on but the point is Enbridge continues to combine reliable earnings, increasing dividends, and controlled growth. That's tough to top.
The company is expected to earn about $2.60 a share in 2010 and close to $3 a share next year.
Action now: Enbridge remains a Buy with a revised target of $53. I have set a $41 revisit level.
Tom Slee writes:
One of the first things I learned in this business was to keep an eye on the Dow Jones Transportation Index (DJTI). Often referred to as the "Canary in the Coalmine", it's one of the few worthwhile market indicators. As Charles Dow himself discovered, no upward movement in the Dow Industrials is sustainable unless confirmed by the DJTI and for good reason. The two indexes are correlated; dependant on each other. As the traders say, one "makes", one "takes" and the relationship holds true even in these modern times. The Dow Jones Transportation Index has led every major rally since 2004. So despite the recent choppy markets I remain very encouraged. As of Friday's close, the DJTI is up a solid 6.7% since Jan. 1, while the Dow Industrials is ahead a meager 3%. Our canary is alive and well.
I am not for a moment suggesting that the market is going to take off just because one index is sending the right signals. There are, however, some good fundamentals supporting the DJTI's strength that bode well for stocks generally. The railway industry, which forms a large part of the Transportation Index, has weathered the downturn surprisingly well. Traffic was certainly down but the companies not only maintained their rates but made increases stick. It was a remarkable achievement during the worst recession since the Second World War. Trucking firms, by contrast, were slashing prices to stay alive. Moreover, most of the Class 1 rails have used the last two years to pare expenses and are now sitting on substantial cash balances. They are already benefitting from the upturn.
That having been said, there is a limit to cost cutting and this year any meaningful improvement in earnings growth depends on increased revenues. We need top-line growth and although there are some encouraging signs the prospects for business are mixed. Some forecasters are extremely cautious. Standard & Poor's recently published an analysis that remains "neutral" about railroads. There is concern about the huge stockpiles of coal that utilities were building towards the end of last year. These will dampen shipments in 2010.
Personally, I am much more optimistic about the railway companies. My feeling is that the buoyant Dow Jones Transportation Index has got it right. There are several reasons for this optimism.
First, we have seen a steady improvement in the shipment numbers for the last six months and there is increasing momentum. Demand for potash is finally picking up and the Canadian Wheat Board recently increased its export projections by two million tons to the highest level in 10 years. NAFTA surface traffic has grown for six consecutive months. So there is no need for a sudden turnaround, just a continuation of the present trends.
I also think that the cautious 2010 shipment forecasts issued by several of the railways are too pessimistic. You can understand why. CEOs, still licking their wounds from 2009, are inclined to aim low and hopefully surprise shareholders by beating the forecasts. The customers, on the other hand, are expecting a lot of activity. A survey released by the Canadian Institute of Traffic and Transportation in late December showed that shippers are calling for an 8% increase in volumes this year. In addition, they believe that core freight rates will rise 2% in 2010. If that outlook is reasonably accurate, and keep in mind that these are the people paying the bills, we should see something like a 10% growth in railway industry revenues this year.
In turn, because the companies have been shedding overhead, a lot of this income will flow to their bottom lines and improve the operating ratios (the percentage of sales needed to run the railway). Any pick-up in the economy will also help. Business inventories are low and even a slight increase in demand will spur shipments, especially intermodal loadings where rails have a big edge over trucks.
All of this points to much better earnings in 2010 than analysts are expecting. In fact, the numbers may be much higher and I am bullish on the stocks, especially as they are still relatively cheap. At the moment, CN Railway is trading at less than 15 times this year's forecasted earnings. Union Pacific also has a 15 P/E multiple, well below the 17 times we can expect in the railway sector during a recovery.
The fact that the threat of new regulations has receded is another plus. For several years now shippers have been complaining to Congress about freight rate hikes and demanding regulatory relief. The Surface Transportation Board actually decided against the rails in several rate cases in 2009. Now though, it looks as though Congress is losing its appetite for more controls. As Gordon discovered at the recent World Money Show in Florida, many Americans want government to butt out. As a result, it's likely that several pending railway rate bills will be allowed to die on the order papers.
Another plus is that investors are beginning to realize that the new Panama Canal expansion will not siphon off a lot of railway traffic from the west coast ports, at least not for five or six years. The new lock capacity will not be ready until 2014 at the earliest. Even then Asian shippers are going to assess the new facility before redirecting their Eastern Seaboard traffic. Moreover, there is already talk of higher canal tolls and the aggressive railways are going to respond to the new competition.
Turning to the railway companies themselves, Canadian Pacific (TSX, NYSE: CP) has the most potential but also the most unpredictable earnings. Take the company's fourth-quarter performance for example. At first glance, the numbers were encouraging. Operating profit came in 94c a share, well above the 89c consensus. Operating expenses were down 17% year-over-year and this partially offset a 16% drop in revenues. As a result, and assuming strong grain shipments during the first half of 2010, CP should make about $3.35 a share this year and $3.90 in 2011. CEO Fred Green, however, lost no time in dampening expectations. He told analysts that he sees little cause for optimism and spoke about a "difficult" prolonged period. It was a somber message.
Part of the problem, I suspect, is that CP is now facing some fundamental difficulties. The company is going to need significant levels of capital spending in order to upgrade and expand its network. Rising taxes and increased pension contributions also loom. There is going to be a substantial cash drain. To make matters worse, CP has become engaged in a serious pricing dispute with Teck Resources, its largest coal customer. Presumably Mr. Green will resolve this but it's a public relations disaster and makes investors uneasy.
So that there is no misunderstanding, I still think that Canadian Pacific Railway will do relatively well in 2010. The Street's target for the stock is through $60 and it is currently trading at C$55.10, US$54.24. But given the choice between Canada's two major railroads, I much prefer CN. In the U.S., I like Norfolk Southern. Both have fewer question marks and both are already on our Buy list. See my updates for complete details.
Finally, here is a quick note about the Canadian banks' first-quarter results. In short, they were excellent! Overall industry earnings were almost 10% above expectations and analysts are scrambling to upgrade their 2010 earnings estimates. I will provide a more detailed update next time, but I am moving our target on TD Bank up to $82 immediately. The shares closed on Friday at C$74.70, US$73.51.
TOM SLEE'S UPDATES
CN Railway (TSX: CNR, NYSE: CNI)
Originally recommended on May 6/02 (IWB #2218) at C$25.95 (split-adjusted). Closed Friday at C$59.99, US$58.88.
CN reported a fourth-quarter profit of 90c a share, in line with the 91c consensus estimate. The good news was that the company also announced an increase in the quarterly dividend to 27c and a 15 million share repurchase program (3.2% of the float). It was a display of strength and confidence that few Canadian companies could match right now.
Looking ahead, CN should benefit from increased grain exports and record U.S. corn and soybean crops. Heavy capital investments over the last few years are also expected to start paying off, especially at the Memphis yard and in Prince Rupert, B.C. The company hopes to capture another 1% of the North American container market. You get the feeling of a company on the move, with or without a strong business recovery. At the same time, the balance sheet remains strong and the free cash flow in 2009, a difficult year, was close to $800 million.
Earnings of $3.90 a share are expected in 2010 with an increase to $4.50 next year.
Action now: CN Railway is a Buy with a target of $65. I have set a $50 revisit level.
Norfolk Southern Corp. (NYSE: NSC)
Originally recommended on Dec. 14/09 (IWB #2944) at $52.22. Closed Friday at $55.33. (All figures in U.S. dollars.)
South of the border, Norfolk Southern racked up a fourth-quarter profit of 82c a share, close to the 84c Wall Street was expecting. The numbers were solid across the board with coal shipments particularly strong. Most important, Norfolk was able to maintain its third-quarter top-line momentum.
Nearly all of the medium-term trends in NSC's markets remain favourable. Norfolk has a strong intermodal franchise in an area where hard-pressed trucking companies are being forced to raise rates. That gives management the happy choice of either raising rates as well or grabbing market share. The outlook for metallurgical coal is improving and NSC is well positioned along Eastern Seaboard to service China's growing need.
What I particularly like about Norfolk is its diverse customer base, strong balance sheet, and relatively low 73.9% operating ratio. This is a railroad that can continue to make money even if the recovery is stalled. Assuming at least some modest improvement in demand this year, NSC should make about $3.75 a share in 2010 followed by $4.50 or more in 2011.
Action now: Buy Norfolk Southern with a target of $62. I will revisit the stock if it drops to $45.
Bombardier (TSX: BBD.B)
Originally recommended on Oct. 19/09 (IWB #2937) at $5.03. Closed Friday at $5.87.
Turning to another sector, Bombardier had a good third quarter, reporting earnings of 10c a share (the company reports in U.S. dollars), slightly above the 9c consensus estimate. Revenues of $4.6 billion were flat year-over-year and the company's all-important operating margin came in at a respectable 9.5% with a strong Transportation division more than offsetting the relatively weak Aerospace segment. On balance, given the tough business jet market, it was a respectable performance.
What I find encouraging about Bombardier is that the company is slowly but surely becoming better balanced. Management is building a solid, reliable Transportation base under its volatile Aerospace business. Trains now account for about 55% of sales and 62% of BBD's $47.4 billion backlog. That may take away some of the stock's glamour but it does make things much more comfortable and predictable for long-term investors. It's also the reason that I now regard BBD as a growth stock with trading opportunities as a bonus.
Not that I am despondent about the aerospace markets. In February, the company announced that it had delivered 176 business aircraft as well as 121 commercial and five amphibious aircraft in fiscal 2010 (the company's year- end is Jan. 31). There was a modest improvement in new orders during the period and there are now indications that the jet market bottomed in the second half of last year.
The big news, though, is that Bombardier has finally bagged a big North American order for its CSeries airliner. A few weeks ago, CEO Pierre Beaudoin announced that the company had signed a contract with Republic Airways for 40 of its new CS300 model along with an option for 40 more. This is a real breakthrough and not only almost doubles the European orders for CS planes already on the books but also provides an incentive for other American airlines to jump in and buy. Incidentally, the CS300 can be configured to seat as many as 149 passengers and propels BBD into direct competition with Boeing and Airbus. For now, though, these giants have no comparable medium-sized plane in this 6,000 aircraft market. Bombardier has a great opportunity to make some inroads.
A word of warning: because of it its exciting aerospace exposure, BBD is a media darling and good as well as bad news is often blown out of proportion. As a result, the stock is jerked around. It's not for the fainthearted. However, the numbers are improving and the prospects look brighter.
Action now: Bombardier remains a Buy with an increased target of $6.75. I will revisit the stock if it drops to $5.
Potash Corporation of Saskatchewan (TSX, NYSE: POT)
Originally recommended on Jan. 28/08 (IWB #2804) at C$133.98, US$132.74. Closed Friday at C$123, US$121.16.
Over at Potash Corp., the recent fourth-quarter results were less encouraging. POT earned 80c a share (the company reports in U.S. dollars) but that included a gain of 9c from foreign exchange. Operating income was 71c a share, well below the 79c Bay Street had been expecting. Margins were squeezed by weak offshore sales and higher energy costs.
This stock, as you know, is really a play on world-wide demand for fertilizer. As a matter of fact, the company accounts for 20% of the global markets. It's a one-commodity player, which is fine except that short-term demand for potash is extremely difficult to forecast. Prices are not directly related to economic trends. They depend to a large extent on unpredictable climate conditions and crop yields.
As a result, POT's earnings are volatile. For instance, in 2008 things were booming and at one stage potash, which some experts believe can be mined and marketed for US$70 a ton, was priced as high as US$1,000 in some countries. Potash Corp. earned an impressive $11.05 a share. Then last year the grain markets collapsed and farmers slashed their expensive fertilizer purchases. They preferred to skimp. Potash prices plummeted and POT made a paltry $3.25 a share.
Demand has picked up a little recently but only in fits and starts; on a contract by contract basis. As recently as February, Israel Chemicals was selling potash at US$355 a ton to China, although POT refused to do a deal at that level. The outlook is mixed. That is why CEO Bill Doyle's announcement on March 12 that Potash is going to earn as much as $1.50 a share in the first quarter surprised the market. POT jumped 6.5% to almost $128. There was talk of resurgent potash markets. It seemed almost too good to be true.
Now that they have had time to mull over the news, some analysts are a little puzzled. Mr. Doyle, who should certainly know, spoke in terms of a "kick- start rebound" in prices but there is little evidence of this. Farmers have been cautiously restocking but as the recent contracts showed, there is no buying wave. I would also like to point out that while the improved guidance is welcome, it's hardly a bonanza for POT.
Given the hard numbers available, an average price for potash in the US$450 range this year seems to make sense. Using this forecast, POT should make about $5 a share in 2010. With the stock trading at $123 that means it has a price-to-earnings ratio of 24.6. Even straight lining Mr. Doyle's new guidance, a dangerous idea in the potash business, we have a 21 P/E multiple. So the stock is fully priced at the moment. By the way, for this purpose I have assumed a Canadian dollar at par.
Nobody seriously doubts that the long-term outlook for potash is solid. There are 6.6 billion people on the planet and that number is expected to climb to 8.2 billion by 2030. In addition, many people are eating a great deal more. We are going to need a lot more food and a great deal of fertilizer.
Nevertheless, I think that we will have to wait until 2011 or even 2012 for a significant increase in POT's earnings. Also, there are several recent developments that concern me. Brazilian mining giant VALE has acquired Bunge's phosphate operations for US$3.8 billion and BHP Billiton has purchased Athabasca Potash. As a result, there are now two new huge, well-heeled competitors in the potash business. In addition, there are reports of poor corn yields.
On balance then, I think that Potash becomes a Sell at the current level for investors who want to take advantage of the price spike and use the money elsewhere. For those able to take a long-term view, the stock remains a Hold, at least until we see the second-quarter results.
Action now: Potash Corporation is a Hold for long-term investors. Short-term traders should sell. I will continue to monitor the stock.
Enbridge Inc. (TSX, NYSE: ENB)
Originally recommended on Aug. 23/99 (IWB #9930) at C$16. Closed Friday at C$48.48, US$47.74.
Enbridge, as expected, delivered a solid fourth quarter. Earnings came in at $300 million or 81c a share compared to $264 million or 72c a share the year before. After adjustment for special items, the company made 65c a share, in line with expectations. Earnings of $2.37 a share for the year were slightly above management's $2.30 - $2.36 guidance range.
Those are impressive numbers and they are only part of the story. Enbridge also revealed that new projects are being brought into service while others are on time as well as on budget. Management announced ahead of the earnings that it has entered into leases with Statoil to transport 30,000 barrels of bitumen a day from the oil sands. The arrangement is expected to grow to 220,000 barrels a day and provide additional pipeline expansion opportunities. Later this year, the Alberta Clipper line between Alberta and Wisconsin and the Southern Lights line, designed to transport light oil from Chicago to the oil sands, are both scheduled to commence operations. I could go on but the point is Enbridge continues to combine reliable earnings, increasing dividends, and controlled growth. That's tough to top.
The company is expected to earn about $2.60 a share in 2010 and close to $3 a share next year.
Action now: Enbridge remains a Buy with a revised target of $53. I have set a $41 revisit level.
