(The following story by Scott Deveau appeared on the Financial Post website on January 29.)
OTTAWA — Despite the current market volatility, dwindling freight volumes, and high fuel prices, analysts remain bullish on most of North America’s top-tier railways.
Savvy investors have been watching this week for any pullback in the share price of the Big Six as they continue to report a soft fourth quarter and express a cautious outlook for 2008. Lower U.S. freight volumes and a sharp rise in fuel prices have undercut the earnings at most railways in recent months.
However, long-term rail investors believe that, despite the current conditions, pricing power has returned to the rails, and that increased global trade and the prospect of taking market share from their main competitor, the trucking industry, which has been hit harder by high fuel prices, will keep rail earnings chugging along in the future.
Typically, top-tier railways trade between 11 and 15 times projected earnings. Any drop below 13 times will have investors bolstering their portfolio of Norfolk Southern, Union Pacific, Burlington Northern Sante Fe Railway Corp. and Canadian National Railway Co. (CNR/TSX) because of their industry-leading positions.
The rails, on average, were trading yesterday at 14.4 times projected 2008 earnings, according to Standard & Poor’s data.
In terms of Canada’s largest railways, CN and its smaller rival, Canadian Pacific Railway Ltd. (CP/TSX), took divergent paths in the minds of most analysts in 2007.
Most remain bullish on CN because of the ramp-up of its new facility at the port of Prince Rupert, its continued operational efficiencies, and its ongoing share-buyback program. But they are less optimistic about CP, which will release its fourth-quarter earnings this morning.
CNR shares closed yesterday at $49.18, up 39¢, or 0.8%, while CP closed at $63.27, down 34¢, or 0.53%.
Last September, CP said it would cancel its share-buyback program in favour of acquiring Dakota, Minnesota, & Eastern Railway Corp. for nearly $1.5-billion, which has been held up by regulators, and is expected to monopolize most of the railway’s free cash in the near term.
“While we continue to believe in CP’s long term-strength, we do expect some shorter-term challenges as it remains focused on closing its acquisition of the DM&E,” said National Bank Financial analyst David Newman in a note to clients.
CN said last week it expects its earnings to grow in the mid-to-high single digits in 2008, or to between $3.57 and $3.70 a share. They said they expect the economy makes a “soft landing” in the latter half of the year.
But UBS analyst Rick Paterson said any such guidance is not worth much given the current uncertainty surrounding the North American economy.
“Investors eagerly await EPS guidance but in reality these companies are likely just as clueless as Wall St. with regard to the 2008 economy,” he said.
New York-based Bear, Stearns & Co. analyst Edward Wolfe is urging investors to take a broader perspective in building a case for the rails.
“We are increasingly bullish that the transports will lead the economy out of the downturn and that rail [volumes], while not currently improving, are close to the bottom after 14 months of [year-overyear] comps,” he said in a note to clients last week.
Over the past 25 years, Mr. Wolfe notes that whenever the U.S. Federal Reserve begins a steady pattern of slashing interest rates, like it began last September, the railways have outperformed the S&P 500. In the past four so-called “easing cycles,” the average S&P 500 earnings increased 7.6% in 12 months, while the rails grew on average by 24.9% over the same period.
Mr. Wolfe recently upgraded the entire rail sector from “market weight” to “overweight.” He said his top pick was Norfolk Southern, but he also upgraded UP, BNSF, and CN to an “outperform” from a “peer perform.”