3 Reasons to Avoid Canadian Pacific Railway Limited

Shares in Canadian Pacific Railway Limited (TSX:CP)(NYSE:CP) have been terrific performers. Here are three reasons I’d sell the stock if I held it.

| More on:
The Motley Fool

Over the last five years, investors in Canadian Pacific Railway Limited (TSX: CP)(NYSE: CP) have been a happy group. After a somewhat lacklustre performance between 2009 and 2011, billionaire investor Bill Ackman came in and influenced the company to shake things up. Ackman essentially forced out then-CEO Fred Green, replacing him with former Canadian National Railway Company (TSX: CNR)(NYSE: CNI) head E. Hunter Harrison.

Since Harrison took over, the stock has been on a tear. Shares are up nearly 300% based on increased rail traffic used by Alberta’s energy patch, as well as increased grain transport. Costs have also been cut, which helped lead the company to great results in 2013, with profit coming in at nearly $5 per share. Based on that, shares have recently broken through $200, resting today at around $207 each.

Considering the company’s impressive results, should investors start loading shares into their accounts? Hardly. I’d avoid the stock, especially at these levels. Here are three reasons why.

1. Valuation

Although it’s backed by solid results, there’s no denying that Canadian Pacific Rail is an expensive stock.

As mentioned, the company earned almost $5 per share in 2013 on revenue growth of approximately 10% year over year. Results so far in 2014 have been good, putting the company’s trailing 12-month earnings at $5.84 per share. Based on those earnings, shares trade at more than 35 times earnings.

That’s expensive for even a high-growth technology name, and especially so for this company. Earnings are expected to rise to $8.58 per share in 2014, but that’s including some very ambitious targets. Both third and fourth quarter earnings will need to rise more than 40% higher than last year just to meet expectations. Even if the company does hit its ambitious price target, it still trades at 24 times forward earnings. That’s expensive, no matter how you justify it.

One small earnings stumble could send shares of Canadian Pacific down sharply. That’s the nature of stocks that are dealing with such growth.

2. Pipeline capacity

To characterize Canadian Pacific Rail’s success as an oil-by-rail story is simplistic, but the fact remains that it has taken advantage of this trend.

For the most part, business looks good. Pipeline capacity is woefully inadequate, and new terminals are popping up everywhere to facilitate the transfer of crude onto rail cars. If you believe the management of both Canadian Pacific and Canadian National, the cost of shipping oil by train isn’t much higher than by pipeline.

Of course, pipeline operators know this as well, and are pushing hard to add the pipeline capacity needed to capitalize on this trend. Enbridge Inc made headlines earlier this year with the approval of the Northern Gateway pipeline, and TransCanada Corporation’s Keystone XL pipeline should get approved sometime in 2015. Other players in the sector are also adding pipeline capacity. These projects won’t make a huge difference in the short term, but in the long term they could take a big bite out of the oil-by-rail business.

3. Grain transport

Ottawa recently instituted a new law called the Fair Rail for Grain Farmers Act, which stipulates that both Canadian Pacific and Canadian National must dedicate a certain percentage of their fleet toward transporting grain. Farmers were upset over the winter when both railroads didn’t bother to transport last year’s bounty, since they were too busy with oil. This led to the government stepping in and creating this new law.

In the long run though, the act may prove unnecessary. Crop yields hit record levels in 2013, and were also strong in 2012. This year’s crops, however, aren’t looking nearly as good. Both Saskatchewan and Manitoba were ravaged by floods, and Alberta has seen its share of nasty weather.

For Canadian Pacific, it’s simple. Less harvested grain is bad for business. It won’t make a huge difference, but the company needs operations to run smoothly if it’s going to meet those ambitious growth targets.

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 Nelson Smith 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.

More on Investing

Oil pumps against sunset
Investing

Oil or Tech? Why Choose When You Can Get Both in a Single Stock?

Tech stock Pason Systems (TSX:PSI) is exposed to the energy market boom.

Read more »

A red umbrella stands higher than a crowd of black umbrellas.
Investing

Protect Against Inflation With 2 Top TSX Stocks

Here are two top TSX stocks that long-term investors concerned about inflation may want to consider in this time of…

Read more »

Woman has an idea
Tech Stocks

The Smartest Stocks to Buy With $20 Right Now and Hold Forever

These under-$20 stocks have the potential to grow further with time and deliver solid capital gains.

Read more »

A close up image of Canadian $20 Dollar bills
Dividend Stocks

TFSA Investors: Put $45,000 in These Top TSX Stocks and Watch Your Passive Income Roll In

Are you looking to retire early? Here are a few ideas about how your TFSA could earn a passive-income stream…

Read more »

Human Hand Placing A Coin On Increasing Coin Stacks In Front Of House
Dividend Stocks

Love Passive Income? Here’s How to Make Plenty of it as a Real Estate Investor

You could definitely create passive income by investing in pure real estate, but you could make just as much, if…

Read more »

Make a choice, path to success, sign
Dividend Stocks

2 High-Yielding Dividend Stocks You Can Buy and Hold for Years

These two high-yielding dividend stocks can be the perfect addition to your portfolio, as the bear market causes payout yields…

Read more »

A worker uses a laptop inside a restaurant.
Tech Stocks

Why Investors Shouldn’t Give Up on Shopify Just Yet

Here's why long-term investors may not want to throw in the towel just yet on e-commerce juggernaut Shopify (TSX:SHOP).

Read more »

Retirees sip their morning coffee outside.
Dividend Stocks

TFSA Wealth: How to Turn $88,000 Into $1 Million for Retirement

Canadians can use the TFSA to hold a basket of diversified equity investments, allowing you to turn a $88,000 investment…

Read more »