Trade wars can change where Canadian goods are sold, certainly. Yet they don’t eliminate the requirement to physically get those goods there.
A new overseas customer still needs a railway, port and shipping route. That makes transportation infrastructure an interesting second-order way to invest in Canada’s attempt to diversify trade away from overdependence on one market. Yet another route only creates value if somebody actually puts freight on it.
Source: Getty Images
Follow the cargo
A railway can benefit when exporters seek new ports or customers. It can also lose business if tariffs reduce trade overall. That’s why I wouldn’t assume trade diversification automatically increases rail volumes. Some cargo may simply travel somewhere different.
Canadian Pacific Kansas City (TSX: CP) offers a particularly useful network for watching that shift. CPKC connects Canada, the United States and Mexico and reaches ports on the Pacific, Gulf Coast and in Mexico. Few competitors can reproduce a three-country rail network without first investing in several decades of growth and an alarming amount of steel. Still, earnings paint the entire picture.
Into earnings
Second-quarter revenue increased 13% to $4.2 billion for CPKC. Revenue ton-miles, which measure one tonne of paying freight moved one mile, increased only 4%. That difference is important. Revenue can rise because of freight mix, fuel surcharges, currencies and pricing without the railway physically carrying 13% more business.
So for Canada’s changing export map, I’d watch actual freight volumes before celebrating the revenue headline. The next number is even more important. CPKC’s core adjusted operating ratio increased to 61.6% from 60.7%. The operating ratio measures operating expenses as a percentage of revenue, so lower is generally better. Right now, that’s about $0.90 less operating income for every $100 of revenue under the adjusted measure.
Meanwhile, core adjusted earnings per share (EPS) still rose 13% to $1.27. That shows why investors should follow both growth and the cost required to produce it. CPKC remains one of the more interesting Canadian blue-chip stocks because its network is extraordinarily difficult to replace.
The problem? The market’s aware
At roughly $122.49, CPKC trades around 28.5 times trailing reported earnings. So that isn’t a bargain valuation. Investors are already paying for years of growth, integration benefits and greater trade across the network.
The dividend yield is also relatively small, so the stock needs earnings growth and capital appreciation to provide most of the return. Trade restrictions, weaker automotive shipments, labour disruptions and congestion can all interrupt that story.
A position inside a Tax-Free Savings Account (TFSA) can shelter successful long-term gains, but it can’t make 28 times earnings cheap after the fact.
Bottom line
Canada’s export map is changing, and CPKC owns an unusually valuable set of routes connecting three major North American economies and several ports. I’d still wait for the freight numbers to prove the opportunity.
If CPKC can attract new traffic while bringing its operating ratio back down, trade diversification could translate into genuinely better per-share economics. The map is useful. The cargo paying to travel across it is what investors ultimately own.
