(The following story by Eric Lam appeared on the Financial Post website on April 29, 2010.)
OTTAWA — Strong first-quarter results this week from Canada’s two biggest railways, Canadian National Railway Co. and Canadian Pacific Railway Ltd., have analysts excited about trains again after a dismal 2009.
Following up on CN’s 21% rise in profit on Monday, CP yesterday reported a 74% earnings increase, beating consensus expectations.
For the quarter ended March 31, CP Rail earned $100-million (59¢ a share), compared with $57-million (36¢) in the first quarter of 2009. Adjusted EPS of 60¢ surpassed the 51¢ forecasted by analysts surveyed by Thomson Reuters.
“I thought both had some of the best results in the North American space, the outlook for both is markedly better,” Jeff Kauffman, analyst with Sterne, Agee & Leach, said from New York. “It was all fantastic, but CP was just a bit better.”
Picking a clear winner is difficult, because the two competitors are not only close together, but also far ahead of the rest of the pack. In particular, both have some of the best operating margins in North America, a measure of efficiency.
“We’re talking about improvements of 4.8 percentage points for CN versus 5.7 percentage points for CP; it’s splitting hairs. Those are terrific,” Mr. Kauffman said.
Brian Yarbrough, analyst with Edward Jones in St. Louis, said there is a “huge opportunity” for CP to close the margin gap with CN, which has traditionally been the market leader.
“CP is seeing a big ramp-up in commodity groups such as sulphur, fertilizer and coal that tanked off last year,” he said.
In the quarter, revenue from that category did jump 55%, to $117.8-million. This is key because commodities account for 46% of CP’s business compared with only about 20% of CN’s, he said.
“CP can get more leverage out of their business model, because they’ve been so inefficient in the past,” Mr. Yarbrough said.
The analysts both had “buy” ratings for the two railways, and said investors can own them at the same time. “They’re in different markets,” Mr. Kauffman said. While CP has key fertilizer contracts in western Canada, CN is more focused on consumer and automotive products in the east.
“Being in the United States we don’t view it as Coke versus Pepsi like the Canadians do,” he said. He has a US$68 target price for CN and US$63 for CP, but that was before yesterday’s earnings call, which will boost it, he said.
Meanwhile, Mr. Yarbrough suggested investors looking for a short-term gain will be better off with CP than CN, which is more of a “slow and steady” earner. “If you’re looking for something that will make the most money over the next two years, that’s CP.”
Since last March, CP shares are up almost 85%, compared with a 60% increase for CN.
Mr. Kauffman said while CP had fallen further behind after getting hammered by commodities last year, the company has also improved its reputation.
“While people tend to give CN credit for doing what they say they’ll do, there’s still skepticism for CP,” he said. “When they come through like this, it is a bigger surprise. I think that will change in the next few years.”