CP Offers Top Potential Rail Return Even After Harrison ExitBy
Potential stock gain at Canadian carrier is industry’s highest
New CEO is relying on sales boost to fuel earnings growth
During Hunter Harrison’s four-year reign at Canadian Pacific Railway Ltd., shareholders about doubled their money. Even after his exit, Wall Street sees more room to run.
The Calgary-based carrier offers the biggest potential return among major North American railroads as Harrison protege Keith Creel takes over as chief executive officer. Canadian Pacific is also the cheapest of the continent’s six largest rail stocks after Kansas City Southern, based on the ratio of stock prices to projected earnings.
To capture the upside, Creel will need to reverse a sales slump -- a different kind of challenge from the ones Harrison tackled. The former CEO, who left to run CSX Corp., whipped Canadian Pacific into shape by cutting costs and speeding up service, turning a perennial laggard into a top performer.
“Volumes are the next step,” Josh Duitz, who holds Canadian Pacific shares as part of the $1.4 billion he manages at Alpine Woods Capital Investors in Purchase, New York. “If you get good volume growth, earnings are really going to start increasing.”
Creel, 48, is targeting percentage growth in the high single digits for adjusted per-share earnings in 2017, which would top last year’s 2 percent gain. His forecast assumes an increase in volumes, in sharp contrast with last year’s 3.9 percent drop in carloads.
He’s off to a slow start. Canadian Pacific’s carloads were unchanged this year through the first nine weeks, trailing the 3 percent increase for major carriers, according to data compiled by the American Association of Railroads.
The new CEO, who took over Jan. 31, is counting on a rebound in bulk commodities, which accounted for about 45 percent of sales last year. Grain, the biggest business line, and potash are poised to climb, said David Tyerman of Cormark Securities.
Boosting revenue with existing resources “is the key to driving additional operating margins,” Creel said in a presentation last month. “Train length matters, train weight matters, train miles matter. And speed matters. Speed is critical to the whole thing. The faster they turn, the fewer you need.”
Creel declined to provide additional comment on his plans, said Marty Cej, a spokesman for the railroad.
Canadian Pacific has the top consensus recommendation among North American railroads and the highest percentage of “buy” recommendations from analysts. It’s poised to return almost 10 percent in the next year, best among peers, according to data compiled by Bloomberg. Canadian National Railway Co., the country’s biggest railroad, is expected to fall 1 percent.
That would be a turnabout from the past 12 months through Friday, when Canadian Pacific’s 19 percent gain trailed the 24 percent advance of its main rival. Both companies beat the 16 percent gain of Canada’s benchmark S&P/TSX Composite Index over the period. Canadian Pacific fell less than 1 percent to C$199.76 at 10:55 a.m. on Monday in Toronto.
Canadian Pacific’s price as of Friday is 17.4 times projected earnings in the next year, the lowest ratio among major North American carriers excluding Kansas City Southern. CSX, buoyed by speculation over Harrison’s arrival as CEO, is now the continent’s most expensive large railroad stock with a P/E ratio of almost 24.
One danger to Creel’s plans is the possibility of a U.S. tax on imports that has been promoted by President Donald Trump. But Creel said he expected that any effects from a border tax would be offset by a weakening Canadian dollar.
That leaves boosting sales as the most pressing challenge. Harrison, 72, cut the operating ratio, a closely watched efficiency gauge in which lower is better, to less than 59 percent last year from more than 83 when he took over in 2012. In addition to a commodities rebound, the company is targeting higher market share by taking on trucking companies with faster and more reliable service, Creel said.
“You can only go from a mid-80s operating ratio to mid-50s once,” said Michael O’Brien, lead manager of the C$5 billion TD Canadian Equity Fund, which owns Canadian Pacific shares. “There will be a new, more mature phase for the company.”