Canadian Pacific Railway has recently been renamed to Canadian Pacific Kansas City Railroad (TSX:CP). This represents a massive shift for this Canadian blue-chip stock. CPKC was formerly the smallest Class One railroad in North America. Its operations were limited mainly to Canada and the northern United States.
After finalizing the merger with Kansas City Southern earlier this year, its network nearly matches the size of its closest competitor, Canadian National Railway. Both have around 20,000 miles of track today.
Reasons to be bullish over Canadian Pacific stock over the long run
However, the merger massively differentiates CPKC. It will now have the only rail network that spans from the Pacific to the Atlantic and across Canada, America, and Mexico. Other than the added size and scale, here are more reasons to be bullish on the combined entity.
Firstly, after COVID-19 and the subsequent supply chain challenges, manufacturers are diversifying their supply chain. Many North American companies are moving manufacturing capacity to Mexico. That means CPKC has a large opportunity to consolidate the freight movement between key manufacturing hubs in North America.
Secondly, prior to the merger, Canadian Pacific was one of the leading railroads for efficiency and profitability. Under CEO Keith Creel, the company has adopted precision scheduled railroading, which has helped increase volumes while reducing costs.
For several years, it had a leading operating ratio below 60%. That has creeped up after acquiring KCS, but management believes it will improve steadily as the entities integrate. In 2022, CPKC had near 40% net income margins, which are industry-leading.
Lastly, the combined CPKC has significant land, terminals/storage assets, and port capacity to grow over time. No company has a direct line across North America, so there are significant savings to be had by shippers going with CPKC. CPKC has a lot of opportunity to provide value-add services to shippers, which will help differentiate it.
Canadian Pacific stock has been a leader long-term
Overall, CPKC certainly looks like one of the more exciting railroads to own as a long-term investment. The transnational railway is already a proven winner. It has provided market-leading returns of 15.4% compounded annually over the decade.
Right now, management believes it can reasonably double earnings to $8 per share by 2028. CP has compounded earnings per share by around a 15% compounded annual growth rate for the past decade. It is not unreasonable that it could achieve this for the coming five years.
A great business but a tough price to pay
Now, one thing investors do need to consider is the valuation. CPKC is an expensive stock. It trades at 25 times earnings, which means the market is already expecting big things. Most peers trade for 20 times earnings or less. CPKC only pays a small 0.7% dividend. However, I like it that way. It can re-invest more of its free cash flow back into growing its franchise and compounding earnings.
Unfortunately, given the elevated valuation, investors do need to be a bit cautious. Management needs to execute very well to justify a higher stock price. Given the current macro-economic worries about a recession, that may take longer than expected.
As a result, investors might want to be patient and wait for a pullback to add to the stock. Undoubtably, CPKC will have industry leading growth for some time, but there could be better opportunities to add to the stock if temporary performance dips. If that is the case, it would be time to load up and ride this stock for a very, very long time.
