Can This Railway Carry High Expectations?

Bound For Success Or Remain With The Rest?

Jul 21, 2014 at 11:57AM

Canada Pacific (NYSE:CP), with lines stretching from Vancouver to Montreal and with routes into New York and as far south as Kansas City, has just come off a banner year of freight transport. Is this railway a true source of value, or should investors be careful of a story that seems to good to be true?

Current status
Last year was a banner year for Canada Pacific. In 2013, revenue increased by 8% to $6.1 billion (all monetary amounts in Canadian dollars), compared to $5.6 billion in 2012, and net income increased from $484 million in 2012 to $875 million due to increased freight traffic and lower management costs. Additionally, it appears that Canada Pacific raised its free cash flow to $530 million in 2013, from $93 million in 2012. In addition to its financial situation, Canada Pacific has improved many of its business metrics.

Metric

2012             

2013                       

Change

Terminal dwell ( in hours)
 

7.5

7.1

5%

Fuel efficiency
(gallons per gallon transit mile, in  000s)

1.15

1.06

8%

Train weight (tons)
 

6,709

7,573

13%

Train length (feet)
 

5,981

6,530

9%

Number of carloads per year
 

2,669

2,688

19 cars

Train speed (miles per hour)
 

18.0

18.2

0.2 mph


Two of Canada Pacific's most important metrics fell over the year: terminal dwell, or the average time that a train spends in station between origination and destination, and the amount of fuel required by a locomotive to pull for a gross ton mile. These two decreases mean that Canada Pacific is moving freight faster and more efficiently than in previous years. Additionally, train weight, train length, number of carloads, and train speed all increased in 2013, a good sign because it means that Canada Pacific was able to transport more freight per trip, helping to improve delivery speed and its profitability per trainload.  .

In its  2014 Q1 earnings,  with the quarter ending April 22 2014, Canada Pacific shows every sign of continuing its streak and reported its best ever quarterly earnings. Operating income was $423 million, a 17% increase over Q1 2013. This arose from a $42.3 Million decrease from employee compensation with consolidation expected to continue incrementally through 2016. With a net profit margin of 16.83% and a operating margin of 28.03%, Canada Pacific looks to be in a good position to be moving forward.

Moving forward
Looking to the immediate future, Canada Pacific looks to be making really good moves to improve on its current situation. In their Q1 earnings report, the company has already committed to going forward and has expanded on it's pledge to increase shareholder value. The company has already announced the implementation of a share buyback program during blackout periods, or periods during which employees are not allowed to update their retirement or investment plans, and has structured agreements with Canadian financial institutions to buy back 1.3 Million shares at discounted prices. Additionally, Canada Pacific's solid financial performance allowed Standard and Poor's to upgrade it from a BBB- credit rating to BBB, showing that strong financial balance and fiscal discipline are working to Canada Pacific's favor. 

How does Canada Pacific compare with Canadian National?
Canada Pacific has had a great quarter and looks to be moving forward with most of its initiatives, building itself into a strong position. However, compared to its main competitor, Canadian National Railway  (NYSE:CNI), it appears the Canada Pacific loses a little bit of its shine.

Metric/Ratio            

Canadian Pacific       

Canadian National Railway

P/E

31.53

21.51

P/Book

4.75

4.40

P/Sales

5.45

5.33

ROE

14.3%

21.7%

ROA

7.3%

8.4%

Data courtesy of S&P Capital IQ

While the company's current metrics look a little less than stellar compared to CNI, its in the forward looking growth rates where Canada Pacific shows its true value going forward. Current estimates show that the five year forecasted growth for Canada Pacific is an annual growth rate of 18.69% compared to Canadian National at 13.07%. Additionally, CP's PEG Ratio is 1.24 compared to CNI's PEG ratio of 1.54, with investors paying less for CP's future earnings growth than for CNI's. Additionally, CP's management is extremely confident that they will be able to meet its goal in achieving an operating ratio of 65% before its goal of reaching it in 2016. The company has successfully dropped its operating ratio from 83.3% to 76.8% from 2012 to 2013. Additionally, CP was able to raise its return on capital employed (ROCE) from 6.9% in 2012 to 9.5% in 2013, showing that the company is continuing to improve its business processes and justify the current premium on the stock.  

Final Thoughts: This could be the railroad for shareholder value
With solid signs of growth, even in the last winter's harsh conditions, it appears that Canada Pacific has built up both a solid position and will be looking to expand on its recent successes. While this company may seem a bit overpriced when compared to its direct peer, Canadian National, it still appears that it could be a good source of value through its buybacks and improving metrics, though it could take time for this to appear in investors' accounts. While it will still have to focus on improving its business operations to remain competitive, Canada Pacific's recent successes show that it might be worthy of high expectations. 

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Sean Dalton has no position in any stocks mentioned. The Motley Fool recommends Canadian National Railway. The Motley Fool owns shares of Canadian National Railway. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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