Back in 2010, Canadian Pacific Railway Limited (TSX: CP)(NYSE: CP) was one of the worst run railway companies in North America. Then hedge fund investor Bill Ackman bought a substantial stake and started putting pressure for changes at the helm. He ousted board members and helped to hire a new CEO, who with the support of the new board of directors, got to work to fix the company.
That was in 2012 and since then Canadian Pacific has cut costs left and right, bringing its operating ratio closer to industry standards. Management is now comfortable enough with the level of operating expenses that it can ease off on cost cutting and focus its energy more on top-line growth.
This is good news for long-term investors and below are two reasons why I think that even at a price level close to its 52-week high, Canadian Pacific is still a solid long-term investment.
Since 2008, the demand for railcars from energy companies to car manufacturer to farmers has surged. All of these businesses want to move their goods trough rail since it is so cheap to do so. The problem, if we want to call it that, is that building additional railways or railcars cannot be done overnight. Right now, the dynamic is one where demand is much stronger than supply, but that is great news for companies like Canadian Pacific and Canadian National Railway (TSX: CNR) (NYSE: CNI) since they can charge much more for each available slot on their network.
The numbers are there to prove it, with Canadian Pacific’s revenue up 23% since 2010 while Canadian National’s is up 27%. Even better, estimates from both companies are not showing any signs of a slowdown in revenue growth in the coming years. That is because the majority of that demand comes from North American oil producers, which in the past five years have increased their oil production, transforming the U.S. into the third-biggest oil-producing country in the world.
High barriers to entry
Unlike most industries, railways have very high barriers to entry. Any competitor interested in this market would need to invest a massive amount of money just to have a network on the same scale as Canadian Pacific’s. For example, just last year the company invested $1.2 billion in capital expenditures equivalent to 16% of its total revenue.
Then there are the regulatory barriers of entry. Even if a competitor had the necessary resources, it would still need to get approval from all the governments where it wants to build a network. The sheer time-consuming aspect of this process makes any viable competition entering the market almost null.
Such a limited possibility of new competition allows Canadian Pacific to have tremendous leverage when it negotiates pricing with its clients.
The railway business is a great one to invest in if your time horizon is 10 to twenty years. It has strong barriers to entry, won’t be replaced by new technology anytime soon, and is currently in high demand. Canadian Pacific Railway Limited, in particular, looks very promising for the long-term investor.
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 François Denault 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.