The big news after Monday’s close was that Bill Ackman’s firm, Pershing Square, announced that it plans to sell 7 million of the 24.2 million shares of CP Rail (TSX:CP,NYSE:CP) that it owns.
The firm plans to leak the shares out at amounts that will not exceed 10% of the combined trading volume on the TSX and the NYSE over a 6-12 month period, starting June 10th.
The average combined volume for CP shares on both exchanges is about 1.2 million shares per day. Pershing could lose the entire 7 million shares in 58 days if they were to account for 10% of each day’s volume, however, they clearly plan on moving at a slower pace.
While the trading is unlikely to have a material impact on CP’s price, from a sentiment perspective, this is a negative for CP’s stock. Anyone that had been sitting on the fence about taking a plunge into this name has to be influenced by this move. Even those who own the stock are likely to re-think their positions.
It’s been a good year and a half for…..
CP has more than tripled in value since Pershing poured about $1 billion into the stock in late 2011. The holding now accounts for 26% of the firm’s combined assets, therefore, from a portfolio management standpoint, reducing the position seemingly makes sense.
However, Ackman’s not one to shy away from a bold bet (see about his foray into Target several years ago). If he thought this was a company that could triple again, there’s no way he’d be selling down. This leads one to believe there’s more to this than a simple portfolio re-weighting.
The core issue here is more likely to be valuation. CP is an expensive stock. Period. The company trades with a trailing earnings multiple of 42 which is waaay above the 10-year historic average of 16 (according to Capital IQ). With this multiple, CP is getting credit for work that it has yet to do.
Don’t count your chickens
The only way this trailing multiple can be justified is if CP does exactly what’s currently expected of it. Earnings in 2013 are expected to almost double from what they were in 2012, and then grow at a rate of 24% and 18% in 2014 and 2015 respectively. The stock currently trades at a bit less than 15 times the $9 or so analysts expect it to earn, in 2015.
For some perspective, this 2015 multiple doesn’t actually look that bad if we compare it to CN Rail (TSX:CNR,NYSE:CNI), CP’s closest rival. CNR currently trades at about 14 times its expected 2015 earnings. However, CN is only expected to grow earnings at 11% and 9.5% in 2014 and 2015 to get there. If CP were to grow at a similar rate over this period, it would end up with 2015 earnings of about $7.60. The company currently trades at 18 times this stunted figure.
If its performance over the next few years is more in-line with CN’s than is currently expected, you can bet this multiple will pull back, bringing the shares down with it.
The Foolish Bottom Line
Railroads own irreplaceable assets and over the long-term these kinds of assets typically generate a positive return for investors. There are times however when the market gets ahead of itself when ascribing them a value, thus negatively impacting the future returns that they provide. Given CP’s valuation, and Pershing’s actions, this might be one of those times for this company’s stock.
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Fool contributor Iain Butler does not own any of the companies mentioned in this report at this time. David Gardner owns CN Rail.