The Stock Picker’s Guide to Canadian Pacific Railways in 2014

Can the company sustain the super-charged performance?

| More on:
The Motley Fool

Canadian Pacific Railway (TSX: CP)(NYSE:CP) is one of the major recovery stories of the past 18 months, with a share price that has already more than doubled since industry veteran Hunter Harrison took over as CEO in June 2012. His business strategy was simple – improve asset utilisation and operating efficiency and reduce costs.

The improvements have been dramatic – a considerable increase in the operating profit margin, a doubling of the net profit margin and an increase in the adjusted 2013 earnings per share of 49% compared to 2012.

Does the story have more legs?

The actions taken by the new CEO since mid-2012 (some are still work in progress) included a substantial reduction in the workforce, the installation of longer sidings to improve asset utilisation, the relocation of the corporate headquarters to a railway yard, the reduction of the active locomotive fleet and railway cars and the identification and intended sale of surplus real estate.

All the key railcar operating measures, including train weight, train length, car velocity and terminal dwell, improved during this period. Also of significant note is that operating expenses including the major expense items of compensation and purchased services declined by 2% during 2013, indicating the considerable focus on cost control.

Moreover, the cost-cutting did not negatively impact freight revenue generation, which moved ahead by 8% during 2013. Top performing categories were grain, fertilisers and industrial and consumer products. In this regard, carloads were flat for the year but revenues per carload went up by 7%, indicating a higher level of profitability per carload. The all-important operating ratio (the percentage of revenue required to pay for operational expenses) improved from 82.5% in June 2012 to a best-in-class comparable level of 65.9% in the fourth quarter of 2013.

Some would argue that the easy part is over now and that it will become increasingly difficult to drive further operating efficiencies and cost reductions. Based on a comparison of the latest financial results from Canadian Pacific with other industry-leading Class 1 North American railroad operators, it would seem that the company still has some room to improve the operating ratio, profit margins, cash flow generation and return on invested capital. However, the gap has now already narrowed to a level where it would seem that Canadian Pacific will be able to match best in class performance measures in 2014 or latest 2015.

During the coming year, the investor focus will shift from operational efficiency improvements to the ability of the company to grow revenue based on a more efficient operating cost structure and the optimal use of the balance sheet, including higher dividend payments and share buybacks.

Foolish bottom line

As admirable as the 2013 performance was, the share is priced for the good news to continue, trading on an expected 2014 price to earnings ratio of 20 times. This is not cheap compared to other Class 1 railroad companies or to the overall market. The CEO indicated on the recent analysts’ conference call that he still sees considerable scope to improve the business performance in the years ahead. Any indication that the plan is not progressing as expected may be met with disappointment.

However, this is a company with a strong franchise, a much improved operating performance and more good news to come that I would like to own for the long run. However, I’ll wait for a more attractive pricing point to invest.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor  Deon Vernooy does not hold a position in any stock discussed in this article.

More on Investing

Various Canadian dollars in gray pants pocket

For Dividend Income, I’d Buy Telus Stock Over Enbridge Today

Enbridge (TSX:ENB) and Telus (TSX:T) are dividend studs that may be worth buying if you love passive income.

Read more »

Payday ringed on a calendar
Dividend Stocks

These +4% Dividend Stocks Pay Cash Every Month

Want to earn more passive income monthly? These three stocks are great bets for substantial, growing, monthly dividends.

Read more »

Electric car being charged

This Lithium Stock Could Be a Genius Way to Invest in EVs

Here's why Lithium Americas (TSX:LAC) could be the growth stock EV investors are looking for as a way to play…

Read more »

grow dividends
Dividend Stocks

Dividend Investors: 2 Top TSX Stocks With 7% Yields

Great Canadian dividend stocks are now on sale.

Read more »

A data center engineer works on a laptop at a server farm.
Tech Stocks

TFSA Investors: 2 U.S. Tech Stocks to Buy and Hold Forever

U.S. stocks such as CrowdStrike and Datadog have the potential to outpace the broader markets and derive inflation-beating returns.

Read more »

consider the options

Better Buy in September 2023: Battery Stocks or EV Stocks?

Battery stocks and EV stocks belong to fast-growing spaces, but I’m more excited about Lithium Americas Corp. (TSX:LAC) today.

Read more »

stock data
Dividend Stocks

3 Stocks I’d Load Up on When They’re Down

These three stocks have outperformed the market greatly in the long run. They're good considerations for purchases when they are…

Read more »

Businessman holding AI cloud
Dividend Stocks

AI Stocks Are Totally Overheated: Here’s What to Buy Instead

Passive-income stocks like Suncor Energy Inc (TSX:SU) can pay you large dividends in retirement.

Read more »