Canadian Pacific Railway (CP, Financial) is a transcontinental railway in Canada and the U.S. with direct links to eight major ports including Vancouver, British Columbia and Montreal. The company offers a suite of freight transportation services, logistics solutions and supply chain expertise.
From a stock price perspective, Canadian Pacific Railway has been sideways since April 2016. This is a good opportunity to accumulate the stock for the next two to three years.
The first factor that is worth discussing is the company’s valuation. For fiscal 2016, Canadian Pacific reported EPS of $10.29. At current stock price of $145, the stock is trading at an appealing price-earnings (P/E) of 14. While broad markets are trading at relatively expensive levels, the stock has still not participated in the rally and I see upside coming in fiscal 2017.
Looking at forward valuations, the case for investing in Canadian Pacific is even stronger. According to analyst estimates, EPS growth of 14.6% is likely in fiscal 2017. This would imply diluted EPS of $11.8 and a forward P/E of 12.3. Therefore, the stock is certainly worth accumulating from a valuation perspective, and I will discuss the other fundamental factors that support stock upside.
Looking at company specific upside triggers, cost controls a key factor that can translate into stock upside. Just to put things into perspective, Canadian Pacific reported 3% decline in revenue for fourth-quarter 2016, but for the same period, the company’s diluted EPS increased by 25%. Challenging weather conditions and delay in grain harvest resulted in lower revenue. I do expect revenue to show an uptrend in fiscal 2017.
Another point worth noting from a shareholder value creation perspective is that Canadian Pacific reported operating cash flow of $2.1 billion for fiscal 2016 and capital expenditure of $1.1 billion. With $1.1 billion in free cash flows, the company’s financial flexibility remains robust. The company’s current dividend payout is $1.52 per share, and I expect this to sustain and potentially increase in fiscal 2017.
Further, Canadian Pacific expects to increase fiscal 2017 capital expenditure by 6% to $1.25 billion as compared to fiscal 2016. Besides underscoring the point that the company expects better markets in the current year, I expect fiscal 2017 free cash flow to remain in excess of $1.0 billion.
From a balance sheet perspective, Canadian Pacific does have debt of $8.7 billion, but I don’t see that as a near-term or long-term concern. The first point to note here is that the company has properties worth $16.7 billion in its balance sheet; this implies a loan-to-value of 52%. The second key point to note is that Canadian Pacific reported net interest expense of $471 million for fiscal 2016 with an EBITDA of $3.2 billion. This translates into EBITDA interest coverage of 6.8 and ensures that debt servicing remains smooth even with higher levels of debt in the future.
I want to come back to the outlook for fiscal 2017 and mention that the company expects a stronger bulk outlook for the year and that will drive EPS growth coupled with operating ratio as compared to fiscal 2016. Further, the very point that the Fed is considering three rate hikes indicates improving economic activity. This is likely to boost the trade outlook.
From an industry outlook perspective, it is also worth noting here that Canadian Pacific has rail infrastructure positioned to serve the ”‹oilsands, Bakken Shale, Marcellus Shale and major ethanol production areas in the Midwest U.S., connecting them to key consumer markets across the northeast U.S. and Canada. As energy markets improve, I see a brighter outlook in this sector that Canadian Pacific services.
Canadian Pacific has been sideways for a prolonged period and well positioned to trend higher in fiscal 17 backed by solid fundamentals, strong EPS growth expectations and recovering markets the company serves. The stock is worth considering at current levels.
Disclosure: No positions in the stock.
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