OTTAWA — Investors hopped aboard Canadian Pacific Railway Co. after the stock was upgraded on August 26 by an influential U.S. analyst, the National Post reported.
James Valentine, who covers the sector at Morgan Stanley, raised the company’s shares to “overweight” from “equal weight” yesterday, citing CPR’s long-term prospects and low price relative to other transport firms.
The rating move is significant since Canadian railways have been lagging their U.S. counterparts lately in terms of stock performance. The stock (CP/TSX) responded by rising 54¢ to $32.95 yesterday. The 52-week range is $37.98 to $20.
“We believe that the concern over the poor condition of the 2002-03 Canadian grain crop is overshadowing very stro ng management efforts to grow other commodities and cut costs,” said Mr. Valentine.
He wrote that of the 17 air freight and surface transport companies he covers, CPR shares, at 11 times forward earnings, are the cheapest, and it has the second-greatest potential for upside growth. He set a 12-month target of US$25 ($38.88).
“The company has generally been under-promised and over-delivered since its spin-off a year ago,” he added, citing the railway’s cost-cutting efforts.
Its operating ratio — a measure of revenue needed to run and maintain the railway that reflects overall efficiency — has been steadily decreasing.
The ratio fell to 76.3% in the second quarter, down 1.6 points from last year and 5.1 points from 1997.
The lower ratio made itself felt in second-quarter results. Even though revenue was down slightly to $922.5-million from $931.4-million, profit rose. CPR posted a 35% increase in net income — 16% once foreign exchange gains are excluded — as it earned $169-million, or $1.06 per share, versus $126-million (79¢) a year ago.
Mr. Valentine’s report is only the latest of several issued since CPR held a seminar for the analyst community earlier this month. Most seemed to come away from the meeting pleased with, but not overwhelmed by, the railway’s progress over the past year.
For example, Horst Hueniken, an analyst at TD Securities, said there were no surprises at the workshop and he found no reason to raise his earnings estimates for the railway. He maintained his “buy” rating with a target of $39.50.
For the year, CPR is still expecting earnings per share growth of 3% to 5%, and 4% annually through 2004 — comprising 2% volume, 1% from new services and 1% from higher yields.
Still, the company is not without challenges that even Mr. Valentine acknowledges.
Foremost among these is the grain situation, where a poor crop in Western Canada is expected to translate into lower volumes. Grain accounted for $749.3-million of CPR’s $3.7-billion revenue in 2001.
A second concern is the health of the economy since the railways are sensitive to overall economic activity.
As of the week ended Aug. 17, Canadian railways have had mixed results, with carloads down 3.2% from a year ago but trailers and containers up 8.6%. Those results roughly reflect the experience of all the major North American carriers.
Mr. Hueniken noted that CPR executives themselves admit their goals are “aggressive,” especially with respect to yields.
“This is by no means an easy task, and much depends upon good execution. In this latter regard, the “devil appears to be in the detail.” CPR, however, appears to be handling this challenge in a methodical and almost scientific manner, which shows promise. We are inclined to give management the benefit of the doubt,” he wrote.
Among other things, Mr. Hueniken said improved information technology, better asset use, programs to compete with trucks and even the extension of rail sidings — which alone will increase eastward train capacity 23% — are all driving costs out.
The potential upside for CPR’s shares also reflects Canadian railway stocks’ recent weak performance relative to U.S. companies.
A rail report yesterday by UBS Warburg noted that Canadian railways are suffering from both the poor grain outlook and expectations U.S. railways will benefit more from a rebound in thermal coal shipments.
“We believe that Canadian stocks will underperform their U.S. peers in the near term; however, for investors with a 12-month plus investment horizon, the current headwind impacting the Canadian stocks may present buying opportunities as, ultimately, the valuation gap between the U.S. and Canadian stocks will close,” the report said.