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How Does CP’s Valuation Compare to Peers?

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Canadian Pacific’s valuation

Based on price to forward EPS, Canadian Pacific (CP) has historically been valued at a premium compared with peers. The company’s exposure to grain differentiates it from its peers, especially US peers. Again, grain also constitutes the largest commodity group for the company. The steady demand for grain around the world will most likely keep CP’s freight prospects high on that front.

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Price to forward EPS

The forward PE (or price-to-earnings) multiple represents the dollars payable today for every dollar of next year’s earnings per share. CP’s current forward PE multiple is 15.3x, whereas the peer group’s forward PE multiple is 15.8x. This represents a 3.3% premium. However, against the S&P 500’s forward PE of 17.9x, Canadian Pacific trades at a discount of 11.7%.

The health of a railroad is a true reflection of the state of the economy, and the declining carloads are certainly telling a story. The first industry to be impacted due to an economic slowdown is transportation and logistics, and railroads are no exception.

What investors should remember

The company’s aggressive cost-cutting measures should raise its operating margins going forward, and should percolate to the bottom line. Even CP has a silver lining in the form of coal transportation. Teck Resources (TCK), a principle coal producer that CP hauls coal for, issued slightly higher coal production in 2016. Thus, in comparison to rival Canadian National (CNI), CP’s year-to-date drop in coal volumes hasn’t been as bad. CNI’s coal volumes have plummeted considerably on a relative basis in the second quarter of 2016.

In addition, CP’s dividend hike of 43% should attract income investors to the stock. Backed by strong share repurchase activity, the stock could rally going forward. The price of commodities like potash and certain minerals can play a crucial role in CP’s price ability in the near future.

Investors interested in the transportation stocks can consider the Industrial Select Sector SPDR Fund (XLI). Major railroads (CSX) and airlines make up 8.5% and 12.3% of the XLI, respectively.

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