(The following story by Brent Jang appeared on the Globe and Mail website on July 20.)
TORONTO — For budding suitors tracking Canadian Pacific Railway Ltd., the long-term appeal of booming Asian trade may be too much to resist.
An ever-growing stream of Asian consumer goods is flowing into Canada, while Canadian exports include grain, coal, fertilizer and lumber.
A group led by Toronto-based Brookfield Asset Management Inc. sought to acquire CPR in April, and while the Calgary-based company rebuffed that offer, industry observers expect a bidding war for the venerable railway.
“It will be a vote of confidence in our continued trade with China and to a lesser extent, India,” said Barry Prentice, a professor at the University of Manitoba’s Asper School of Business.
Prof. Prentice said potential suitors – including infrastructure investors, pension plans and private equity funds – aren’t likely to be scared off by the cyclical nature of the railway sector, which transports fewer goods when economies slow down.
Even if red-hot Asian economies cool off this year, the growth pattern has been set, he said in an interview yesterday from Winnipeg. “The trend is your friend, and the trend is toward increasing movement of containers off the Pacific coast.”
Industry experts say that CPR holds a valuable franchise among the Big Six Railways in North America. Barriers to entry are extremely high because it would cost billions of dollars for a new player to install tracks and buy trains, not to mention acquire land.
“You’re not going to see another major railway being built, so the investor excitement is also a play on real estate,” Prof. Prentice said.
Amid bustling Asian imports of consumer goods and brisk Canadian commodity exports, CPR’s profit surged last year to a record $796-million, eclipsing its previous annual high of $543-million in 2005. Its revenue rose to $4.58-billion from $4.39-billion, while operating profit climbed 14 per cent to $1.13-billion.
“Demand for rail services has risen over the past several years in conjunction with steady economic growth in North America and a significant increase in trade with China,” RBC Dominion Securities Inc. analyst Walter Spracklin said in a research report.
Two prominent investors, recognizing the long-term trend of growing Asian trade, have helped fuel interest in railways. Microsoft Corp. chairman and founder Bill Gates, through Cascade Investment LLC, is CN’s largest shareholder, with a stake of about 6 per cent, recent filings show.
And U.S. billionaire Warren Buffett has investments in three U.S. railways. Mr. Buffett’s Berkshire Hathaway Inc., which in April disclosed a 10.9-per-cent stake in Fort Worth, Tex.-based Burlington Northern Santa Fe Corp., said in May filings that it owns less than 2 per cent of Norfolk Southern Corp. of Norfolk, Va., and 4 per cent of Union Pacific Corp. of Omaha, Neb.
With high energy prices, railways are proving to be a fuel-efficient alternative to trucks, especially long haul, said Joe Martin, director of Canadian business history at the University of Toronto’s Rotman School of Management.
Canadian National Railway Co., the country’s largest rail freight carrier, will gain an advantage over CPR this fall when the Port of Prince Rupert in British Columbia begins to handle CN’s container traffic.
Potential buyers are zeroing in on CPR because federal rules stipulate that no single shareholder can accumulate more than a 15-per-cent voting stake in Montreal-based CN.
Prof. Martin said CPR is viewed as an underperformer because rival CN has a better operating ratio – a key indicator of productivity that measures operating costs as a percentage of revenue. CN’s 2006 operating ratio was 60.7 per cent, compared with CPR’s 75.4 per cent. A lower operating ratio is better.
Analysts say some of the gap can be attributed to the steeper terrain that CPR trains must conquer.
“CN tracks tend to be more flat, enabling higher speed and reducing the necessity for track and rolling stock maintenance,” UBS Securities Canada Inc. analysts said in a research note.
CPR’s share price has surged 170 per cent over the past three years, buoyed by the bonanza in Asian trade. Takeover speculation pushed the stock up 16 per cent on Wednesday.