Canadian Pacific Railway (“CP”) (CP, Financial)
Beginning in late 2021, we reinitiated an investment in Canadian Pacific. CP has been the best performing railroad in North America over the last decade due to the exceptional leadership of CEO Keith Creel and his predecessor, Hunter Harrison. We first invested in CP in 2011 and recruited industry veteran Hunter Harrison to lead a turnaround of the company. Under Hunter and Keith’s leadership, CP has more than doubled its operating margins from 19% in 2011 to 42% in 2021 and become a leader in profitability among North American Class I railroads.
Canadian Pacific has been the fastest growing North American Class I railroad with average organic revenue growth of 6% over the last five years. In December, CP closed the acquisition of Kansas City Southern (“KCS”), which we believe will be a transformational and value-creating transaction. The acquisition of KCS positions CP to be the only North American railroad with a direct route from Canada to Mexico, and will result in significant revenue and cost synergies. KCS’s rail network is at the center of the North American rail system, linking Mexico to major markets in the Midwest and Southeast regions of the United States. The CP-KCS combination will connect six of the seven largest metro regions in North America in one direct route and offer unparalleled speed and service for customers. CP currently owns KCS through a voting trust, which entitles CP to full economic ownership of the company, but does not permit CP to take operational control of the railroad until it receives regulatory approval of its pending merger application. We expect this approval to occur by the end of the year.
We believe CP is an attractive business as it operates in an oligopolistic industry where the barriers to entry are high due to considerable capital requirements, regulation, and network effects. The company provides a mission-critical freight transportation service which is often the cheapest or only viable method for transporting heavy freight over long distances, allowing for significant pricing power. Moreover, we believe freight volumes for the industry are poised for strong growth as rail freight transportation takes share from trucking. Rail currently accounts for less than 10% of overall freight transportation dollars in the United States with trucking representing more than 60%.
Rail transportation is both cheaper over longer distances than trucking, and significantly more environmentally friendly as it reduces greenhouse gas emissions by up to 75% compared to trucking. As customers increasingly look to reduce their carbon footprints and the railroads continue to enhance their customer service levels, we expect the railroad industry’s share of the freight transportation market to meaningfully improve from current levels. Furthermore, the current geopolitical environment has increased the probability of significant investment in North American onshoring and energy production, which would further strengthen CP’s volume growth over time.
Since we exited our original investment in CP in 2016, we have continued to closely follow the company and have admired the company’s industry-leading execution and operational excellence. We believe the acquisition of KCS will be transformational for CP’s rail network, and expect CP’s leadership team to make significant operational improvements at KCS.
Despite our expectation that CP’s best-in-class recent performance will continue and the company’s future growth profile will be significantly enhanced by the revenue and cost synergies associated with the KCS combination, CP’s shares have recently traded at a discounted valuation relative to history and its peers. We believe that the successful consummation and integration of the KCS acquisition will lead to attractive future investment returns relative to our purchase price as CP generates robust free cash flow per share growth over the medium-term, and which should cause it to receive a higher valuation that is more consistent with historical and peer levels.
From Bill Ackman (Trades, Portfolio)'s Pershing Square 2021 annual letter.
