How Is Canadian Pacific Valued Compared to Peers?



Canadian Pacific’s strong operating focus

Canadian Pacific’s (CP) terminal dwell, a measure in hours that determines the time taken by railcars at terminals to load and unload, is currently its lowest in the last five years. The company has focused on running longer, fewer, and faster trains, which has resulted in cost reduction.

The above graph shows the last-five-year valuation history. After the management change in early 2012, CP’s valuation premium went up compared to its peers. The peer group includes Canadian National Railway (CNI), Norfolk Southern (NSC), CSX (CSX), Union Pacific (UNP), and Kansas City Southern (KSU).

Investors interested in the transportation space can consider the iShares US Industrials ETF (IYJ). This ETF holds 5.0% of its holdings in US railroads.

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Forward price-to-earnings ratio

The forward PE (price-to-earnings) multiple shows how much investors are willing to pay today for one dollar of earnings in the next one year. CP’s current forward 12-month PE multiple is 15.3x compared to the peer average of 15.7x. This represents a discount of 2.5%. The discount has been mainly due to the commodity price concerns in Canada and CP’s unusually high debt levels.

What could drive CP’s valuation?

CP’s management strength is another area investors should look at. Management appears to be confident that it will overcome the expected lower volumes in 2016 through efficiency and productivity improvement measures. The company has guided for double-digit EPS growth in 2016 from 10.1 Canadian dollars per share in 2015. In addition, CP might aggressively start buying back its 0.5 million equity shares with the available cash if it fails to strike a deal on the takeover front.

What could hurt CP’s valuation

The company’s intermodal sector, which accounts for 20% of its revenues, is facing headwinds. This segment has been a mixed bag in terms of growth. Going forward, the state of the Canadian economy and increased trucking capacity in CP’s short-haul lanes will significantly impact intermodal growth.

Secondly, failure on the part of CP CEO Hunter Harrison to strike a meaningful deal either with NSC or CSX might also impact the stock price. His contract is slated to end in the summer of 2017. Investors and credit rating agencies are skeptical about CP’s projected debt-to-EBITDA of 4.0x. Without the takeover proceeding, CP will be sitting on a heap of debt. High debt in the midst of weak industry fundamentals could spell more trouble.


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