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Canadian National Railway Company vs. Canadian Pacific Railway Limited: Which Is the Best Investment?

Profits have been rolling in at Canadian National Railway Company (TSX: CNR)(NYSE: CNI) and Canadian Pacific Railway Limited (TSX: CP)(NYSE: CP), but new investors want to know if the revenue train will continue to to chug along.

Let’s take a look at each company and see if one offers investors a better buying opportunity.

Canadian National Railway Company

Canadian National Railway (CN) has a huge competitive advantage over all the other railways in Canada and the U.S. because it is the only company that can offer customers access to three coasts. With its 32,000 km of rail track, CN is capable of reaching nearly every major U.S. and Canadian market.

The company has focused heavily on growing its intermodal business and now manages more than 20 intermodal terminals, giving customers a more efficient option for transporting goods across the continent. Intermodal freight revenues represented 24% of CN’s Q2 2014 earnings and investors should see that number grow significantly in the coming years, as trucking companies struggle with higher fuel costs and tighter restrictions on driving time.

Transformations in the North American oil and gas industry are all providing a boost to CN’s revenue as Canadian oil producers use rail companies to transport massive amounts of crude to access higher-priced oil markets, and shale-gas producers require sand deliveries for their hydraulic fracturing process.

Risks?
The Canadian government has fined Canadian National for not meeting its weekly delivery obligations of Canadian grain. Transportation bottlenecks on the prairies are not new, and record crops last year resulted in a huge rail delivery backlog last winter. This year’s crop production is down about 20%.

The recent derailment in Saskatchewan will put further scrutiny on rail transport safety, and CN will incur significant costs to clean up the accident.

Canadian National Railway trades at 22 times earnings. The stock has nearly tripled in the past five years.

Canadian Pacific Railway Limited

Canadian Pacific Railway (CP) has gone from being “the little train that couldn’t” to a stock market darling. Most of the credit goes to one man.

Hunter Harrison, the legendary ex-CEO of Canadian National Railway, was lured out of retirement in 2012 to lead the transformation of a struggling Canadian Pacific. The 69-year-old cut more than 4,500 jobs, reduced the number of locomotives it operates, and shut down costly rail yards in an effort to improve margins and productivity at CP, perennially known as the continent’s most inefficient railway.

Canadian Pacific’s operating ratio has come down significantly under Harrison’s watch and most recently sat at 65.1%, second only to Canadian National’s industry-leading 59.6%.

The ratio is watched carefully as it indicates the added cost a railway incurs for every extra dollar of revenue generated.

Canadian Pacific recently stirred up the market by announcing plans to double profits in the next four years by adding more railcars to train routes and running the trains 20% faster.

As with CN, Canadian Pacific is enjoying growth in its intermodal and energy divisions. Crude-oil deliveries are expected to hit 200,000 carloads in 2015, more than double CP’s 2013 number, and Canadian Pacific thinks intermodal revenues will hit $2 billion by 2018. Intermodal revenue was $670 million in the first half of this year.

Risks?
Lower Canadian grain production could impact earnings a bit this year, especially if difficult winter conditions are repeated in 2015. Canadian Pacific has met its weekly grain transport obligations so far and has avoided the fines faced by CN.

Regulation could derail the plans to run faster and longer trains. Oil-by-rail is still a concern for the Canadian public, and CN is dealing with a big derailment in Saskatchewan. Politicians looking for votes next year could decide to place restrictions on the railway companies.

CP trades at 40 times earnings. The stock has risen almost 90% in the past 12 months.

The bottom line?
Canadian National’s network advantage and much lower price-to-earnings multiple make it more attractive right now. Canadian Pacific is priced for perfection and most of the efficiency gains have been realized at this point.

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Fool contributor Andrew Walker 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.

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