Canadian Pacific Railway Ltd. (NYSE: CP), a major railway serving Canada and the northern U.S., is BUY, and our target price is $350, up from $320. Valuations are not cheap, but the premiums are reasonable in the context of the company’s history of outperformance on the rails and in the markets.
The beta on CP is 0.8.
On October 20, CP posted adjusted 3Q EPS that declined 11% from the prior year. Revenue fell 6% to CAN$1.9 billion (better than the 9% decline in 2Q), as freight revenue per ton-mile rose 1%.
Along with the 3Q results, management raised its outlook for 2020. It now expects revenue ton-miles to decline at a low single-digit rate (versus a prior mid-single-digit rate).
EARNINGS & GROWTH ANALYSIS
CP’s top shipment categories include grain (25% of 3Q revenue); energy, chemicals and plastics (17%); metals, minerals and consumer products (8%); coal (7%); potash (7%); and automobiles (5%). Intermodal accounted for 21% of revenue.
Overall in the third quarter, volume – revenue ton miles or RTM -rose 1%, compared to a 6% decline in 2Q. The top-performing categories were potash and grain (12% and 13% revenue growth, respectively). Automotive rose 8%. Intermodal revenue declined 6%, which was an improvement from an 11% decline in the prior quarter. The weakest categories were coal and metals, minerals and consumer products. Looking ahead, we anticipate solid growth in grain shipments in 4Q due to a record harvest in Canada, and double-digit growth in automotive, offset by weakness in energy.
Management keeps a close watch on costs, and CP’s operating ratio is among the lowest in the industry. In 3Q20, the ratio deteriorated by 210 basis points to a still low 58.2%, benefiting from reduced train accident frequency and longer train length. Management is committed to continued cost optimization in line with its three-year financial targets. The company’s goal is to reduce costs by 100 basis points annually. The 2019 operating ratio was 59.9%, down from 61.3% in 2018.
Our estimate implies 6% growth this year. We look for growth to pick up in 2021 and are raising our EPS estimate to $15.00 from $14.50.
FINANCIAL STRENGTH & DIVIDEND
The interest rate on these borrowings is 1.875%. CP pays a dividend.
MANAGEMENT & RISKS
Keith Creel, formerly the company’s president and COO, took over as CEO on January 31, 2017. He replaced the legendary – and late – CEO E. Hunter Harrison, who was the initial architect of the company’s efforts to lower its operating ratio. Mr. Creel had served as the company’s president and COO since February 2013. Prior to joining CP, he held senior management positions at Canadian National, Burlington Northern Railway, and Grand Trunk Western Railroad.
Management held an investor meeting on October 3-4, 2018. At the event, obviously prior to the pandemic, management set the following targets for 2018-2020:
– Compound annual volume growth in the mid-single digits, measured in revenue ton-miles
– Double-digit compound annual growth in adjusted diluted EPS
– Continued margin improvement through cost controls and operating leverage
– Capex of approximately $1.6 billion per year
The railroad industry may be poised for a period of consolidation.
Canadian Pacific has approximately 12,000 employees.
On October 21 at midday, BUY-rated CP traded at $318.37, down $1.39.