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Should You Sell Canadian National Railway Company or Canadian Pacific Railway Limited?

With Canadian National Railway Company (TSX:CNR)(NYSE:CNI) hitting new highs and Canadian Pacific Railway Limited  (TSX:CP)(NYSE:CP) approaching them, investors in both companies should wonder if it’s time to sell and go home.

The macroeconomic conditions for Canada still look tough. Growth has slowed considerably as the country grapples with a volatile housing market, plummeting energy prices, and sky-high consumer debt levels. Even the CEO of Royal Bank of Canada is cautious about Canada’s future, saying the country could take 15 years to “reinvent itself.”

After a strong multi-year run, is it finally time to sell these two railroad stocks?


What does the valuation say?

On an EV/EBIT valuation metric, shares of both companies trade at levels seen in both 2012 and 2015. The multiples are still well off their peaks, and it appears as if investors are pricing in some of the macroeconomic risks mentioned earlier.


You’ll quickly notice that Canadian National has consistently trades at a discount to Canadian Pacific. Over the years, despite some of the best operating efficiencies in the industry, Canadian National has been unable to match the growth of Canadian Pacific.



Why has the valuation fallen?

The chief issue has been lagging volumes growth. Across nearly every commodity segment, Canadian National is feeling volume pressures. Executive Jean-Jacques Ruest said this year that “volume is weak, will get weaker, and pricing is not the greatest.” For example, year-over-year petroleum revenues to dropped 18% last quarter. Metals revenues also fell 18%, and coal revenues fell a steep 42%.

“We continue to experience high volatility and weaker conditions in a number of commodity sectors,” CFO Luc Jobin said on the company’s conference call. “We’ve got our work cut out … there are some challenges out there,” added CEO Claude Mongeau.

How are profits still rising then? Canadian National has boosted profitability through aggressive cost cutting. Last quarter, EBITDA margins jumped from 44% to 51% year over year. This was made possible through lower fuel costs (dropping to 8% from 12%) as well as lower labour costs (now down to 19% of revenues). The average cost per employee was down about 2% year over year, and the employee count fell by 2,400.

Canadian Pacific has also turned to cost cutting in an attempt to stem the tide of weak volume growth. Since 2012 the railway has cut over 6,000 jobs, including 1,200 in 2015. Canadian Pacific, despite the higher valuation, is a bit riskier when you break down its rail car traffic. A massive 42% of volumes come from bulk sources such as grain or coal with another 17% coming from metals, minerals, and crude oil.

Stick with Canadian National

Despite the valuation premium that Canadian Pacific has enjoyed in recent years, Canadian National remains a better business.

Over the past few years, Canadian National has generated an average return on invested capital of about 15%. Canadian Pacific has experienced wild swings from 5% to 13%. Return on equity for Canadian National (now at 25%) has also been much more stable than the of Canadian Pacific.

If you’re choosing to sell either company, stick with Canadian National and ditch Canadian Pacific.

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Fool contributor Ryan Vanzo has no position in any stocks mentioned. David Gardner owns shares of Canadian National Railway. The Motley Fool owns shares of Canadian National Railway. Canadian National Railway is a recommendation of Stock Advisor Canada.

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