2 Reasons to Avoid Canadian Pacific Railway Limited, and 1 Stock to Buy Instead

Canadian Pacific Railway Limited (TSX:CP)(NYSE:CP) has been very rewarding to investors in recent years, but now’s not the time to jump in.

| More on:
The Motley Fool

Over the past couple of years, few stocks have done as well as Canadian Pacific (TSX: CP)(NYSE: CP). Since the beginning of 2013, the stock has more than doubled.

Part of this is due to a much-improved environment for railroads. But most of the credit should go to Hunter Harrison, who was brought on as CEO thanks to a proxy fight led by activist investor Bill Ackman. Mr. Harrison has proved very adept at cutting costs and increasing efficiency — something he’s done at other railroads before.

That being said, there are reasons to avoid shares of CP, and two are shown below. Then we highlight one stock you should buy instead.

1. A couple of headwinds

It’s true that Canadian Pacific has done very well lately. To illustrate, it has lowered its operating ratio (which measures expenses as a percentage of revenue) from over 80% to less than 70% under Mr. Harrison’s leadership. But there are a couple of things to watch out for: One is government regulation. And this has come to light in recent months, thanks to the Canadian government’s mandates regarding the transportation of grain. Most recently, CP has been ordered to transport over 500,000 tons of grain per week through November 29 or face stiff fines. While this alone is little more than an annoyance, it does highlight just how vulnerable the rails are to the government’s whim.

The other is a limited track network, which is not as extensive as that of rival Canadian National Railway (TSX: CNR)(NYSE: CNI). To illustrate, CP’s network extends from Vancouver toward the East Coast — but not all the way — and as far south as Kansas City. Meanwhile, CN’s network reaches the West Coast, East Coast, and Gulf Coast. So CN can more effectively serve its customers, which puts CP under constant pressure.

2. Price

CP trades at a very lofty valuation by almost any standard. According to Morningstar, it trades at over 21 times forward earnings. Suddenly, CN, at 19.4 times forward earnings, doesn’t look so expensive.

The shares are also trading well above Mr. Ackman’s projections when making the case for Mr. Harrison in early 2012. And those projections seemed optimistic at the time. So to no one’s surprise, Mr. Ackman has sold down his CP stake.

1 stock to buy instead: CAE

CAE (TSX: CAE)(NYSE: CAE) is in the business of simulation-based products and services, which are used around the world by airlines and militaries.

Unlike the rails, CAE is not constrained by geography, and thus has far more room to grow. Most promising is growth from emerging markets such as China, where increased air travel is placing greater need for both planes and simulators. There’s also a looming pilot shortage, which places even greater need on CAE’s services.

Better yet, CAE only trades at 15 times forward earnings. So there seems to be much more of a runway (no pun intended) with this company than with the rails, especially CP. The choice should be clear.

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 Benjamin Sinclair 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

Caution, careful
Dividend Stocks

I Wouldn’t Touch This TSX Stock With a 60-Foot Pole

When it comes to a top TSX stock, this energy stock has been doing quite well in 2024. But is…

Read more »

Retirees sip their morning coffee outside.
Dividend Stocks

Retirees: How to Earn $250 Per Month From Your TFSA

Here’s how buying these two dividend stocks now could help you generate attractive monthly passive income from your TFSA.

Read more »

Young woman sat at laptop by a window
Dividend Stocks

GICs vs Canadian Dividend Stocks: What Are the Pros and Cons of Each?

Are you wondering whether to buy GICs or dividend stocks? Here are some thoughts as to why one option is…

Read more »

investment research
Stocks for Beginners

2 Stocks I’d Avoid in 2024 (And 1 I’d Buy!)

While these two stocks have fallen from grace, I would certainly consider this other top performer for 2024, if not…

Read more »

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

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

Investing in undervalued dividend stocks such as Kinross Gold can help you derive market-beating returns in 2024.

Read more »

exchange-traded funds
Dividend Stocks

What’s the Best Way to Invest in Stocks Without Any Experience? Start With This Index Fund

This index fund is perfect for pairing with a few choice Canadian stock picks.

Read more »

Value for money
Investing

3 Canadian Value Stocks to Buy Right Now

These three Canadian value stocks all trade cheaply and have significant recovery potential, making them three of the best to…

Read more »

Different industries to invest in
Dividend Stocks

Better Buy? Telus vs BCE Stock

BCE and TELUS stock have massive dividend yields today. However, these businesses are facing some big issues. Which one is…

Read more »