Class I freight railroad Canadian Pacific (NYSE: CP ) hit an all-time high on Wednesday, as newly installed CEO Hunter Harrison announced new details in his plan to restructure the cost-heavy operator. Canadian Pacific has languished as the least efficient Class I railroad in North America for more than a decade, and many investors believe Harrison, who lead rival Canadian National (NYSE: CNI ) to become the continent's best-in-class operator, is the man to turn things around.
Harrison came to Canadian Pacific only in June, after a vicious proxy battle led by activist investor Pershing Square Group. A major selling point of Pershing's campaign was that Harrison's expertise would be enough to drive the railroad's operating ratio, a critical measure of efficiency, from more than 80% to around 65%, a goal shared by East Coast freight railroad CSX (NYSE: CSX ) and a level already achieved at Canadian National. Harrison has already made some progress by closing some redundant rail yards and sidings, and on Wednesday, Harrison revealed plans to cut around $500 million in costs out of the business through a variety of means.
The biggest announcement was that as many as 4,500 jobs will be eliminated by 2016, about a quarter of the company's workforce, with 1,700 to go this year. While this would typically be seen as a bad sign rather than a good one, Harrison has pointed out that because of the company's older workforce, many cuts could be achieved through attrition rather than layoffs.
Some layoffs are also to be expected, but Harrison indicated that management, rather than unions, would take the brunt of the cuts, telling investors on Wednesday that Canadian Pacific "had too many non-union officer, managers, supervisors, leaders up to the range of 28 to 30 percent. That's far too much." Union spokespeople have not immediately objected, though they have requested additional details on job cuts and promised to follow developments closely.
Harrison also announced intentions to continue his existing strategy of rationalizing railroad assets, attempting to move more freight using fewer trains, selling off non-vital real estate, and, most symbolically, relocating the company's headquarters from a glass skyscraper in downtown Calgary to a large railyard in the industrial suburb of Ogden. That last move will not only save the company $15 million annually, but in Harrison's estimation it will also change the culture of management to focus on the efficient operation of a quality rail line.
King Coal dethroned
Canadian Pacific also decided not to act on its option to expand a recently acquired rail line deeper into Wyoming, to access the region's Powder River Basin coal-producing areas. Canadian Pacific acquired the trackage as recently as 2007, when it bought up the Dakota, Minnesota, & Eastern Railroad for $1.5 billion, and the railroad's access to the Powder River Basin was thought to be the driving rationale behind the deal.
With the advent of low-cost, low-emission natural gas made possible by advances in hydraulic fracturing technology, the bottom has fallen out of the coal market, making transporting the fuel unprofitable. Canadian Pacific is now putting 660 miles of trackage in Minnesota, South Dakota, Nebraska, and Wyoming up for sale, having already taken a $180 million writedown on the purchase.
While the secular decline of the coal industry will make Hunter Harrison's turnaround that much harder, Canadian Pacific is better off than some railroads in this regard. Eastern railroads CSX and Norfolk Southern (NYSE: NSC ) are in the worst position as they are dependent on Appalachian coal, which is even dirtier than Powder River Basin Coal. Earlier this year, sliding coal volumes at Norfolk Southern caused a selloff across the industry, though rosier results from Union Pacific (NYSE: UNP ) indicates that more Western-focused railroads like Canadian Pacific will have an easier time waiting out a recovery in energy prices.
Natural gas prices will recover eventually, however, and Motley Fool lead analyst Joe Magyer believes this will happen as soon as 2014. He's identified one incredible energy company that presents a rare "double-play" investment opportunity today. We're calling it The One Energy Stock You Must Own Before 2014, and you can uncover it today, totally free, in our premium research report. Click here to read more.