As we celebrate Queen Victoria’s 199th birthday this week-end with fireworks, two-fours (Victoria herself preferred Vin Mariani), a public holiday (the only place other than parts of Scotland to do so), and the wedding of her great great great great grandson Prince Harry, let’s also recall one of this country’s greatest engineering accomplishments—the building of the transcontinental Canadian Pacific Railway and the driving of the last spike on Nov. 7, 1885, during the 49th year of Victoria’s long reign.
Both Canadian Pacific Railway and Canadian National Railway disappointed the market in the first quarter of 2018. Even so, CN and CP possess solid long-term prospects.
One bright spot is growing trade with Asia, particularly the Pacific Rim. They need many of the resources that Canada produces. This country, in turn, imports more products manufactured in Asia. With the Comprehensive Trans Pacific Partnership on the way, trade with Asia will grow further. This works to the railways’ advantage.
The fact is, trains are the most efficient and cost-effective way to transport products between the West Coast and the Great Lakes. As a result, CN and CP remain buys for long-term share price gains and growing dividends.
Canadian Pacific from scandal to profitable icon
Born under clouds of political scandal and abusive labor practices, Canadian Pacific has since become an icon of nationhood and celebrated in song by the likes of Hank Snow and Gordon Lightfoot among others (see below.)
Canadian Pacific Railway (TSX—CP), or CP, earned less than expected in the first quarter of 2018. Its revenue rose by four per cent from a year earlier, to $1.625 billion. At the same time, the railway’s operating costs went up by 12.3 per cent, to $1.122 billion. As a result, its net income in the first quarter came to $348 million, or $2.41 a share. This was down by 17.7 per cent from net income of $431 million, of $2.93 a share, a year earlier.
CP reported first-quarter adjusted earnings per share of $2.70 a share. This was up by eight per cent from adjusted earnings of $2.50 a share, a year earlier. Just keep in mind that the railway’s adjusted operating ratio deteriorated by 1.9 percentage points, to 67.5 per cent. (The operating ratio is operating costs as a percentage of revenue. The lower the number, the better.)
President and chief executive officer Keith Creel said: “This was a challenging quarter, as we battled extreme weather and unprecedented demand. . . . With the extraordinary winter weather behind us, we built a tremendous amount of momentum through March . . . positioning us well for the rest of the year.” Some unhappy customers would disagree.
But the market agrees with Mr. Creel. The consensus recommendation of a dozen analysts is ‘Buy’. This year, CP is expected to earn $13.09 a share. That would mark solid earnings per share growth of 14.9 per cent. Based on this year’s estimate, the shares trade at a P/E (Price-to-Earnings) ratio of 17.1 times. That’s not especially cheap, but nor is it too high.
One uncertainty, however, is the impact of troubled relationships between CP and its unionized workers. Train crews and signal workers, for instance, could soon go on strike. The head of the Teamsters Canada Rail Conference, Doug Finnson, described management’s offer as “ridiculous”. He’s quoted as saying: “We’re not endorsing it.” A strike would hurt customers such as grain farmers and the chemical industry. They’re already frustrated with the delay in railway deliveries.
Thanks to growing trade with Asia, CP’s long-term prospects are bright. In fact that’s why it’s opening an office in Shanghai, China. Mr. Creel said: “With a third of our existing book of business already touching Asia and exciting opportunities for growth, now is the time for CP to connect with our customers in Shanghai and across the Pacific Rim.” When the Comprehensive Trans Pacific Partnership takes effect, the railway should prosper even more.
CP has raised its dividend each year since 2015. But due to the high share price, the dividend yields only a modest one per cent. Then again, the company is also buying back its own shares. All else being equal, this will raise its earnings per share by spreading them over fewer shares.
Canadian Pacific Railway remains a buy for long-term share price gains and modest, but growing dividends.
Keep buying Canadian National Railway
Born in much less romantic circumstances, Canadian National Railway was incorporated in 1919, comprising several railways that had become bankrupt and fallen into federal government hands, along with some railways already owned by the government. In 1995 the federal government privatized the company.
Canadian National Railway (TSX—CNR), or CN, earned less in the first quarter of 2018 than a year earlier. Even so, the railway is reinvesting in its business and rewarding its shareholders. Keep buying CN for share price gains as well as decent and growing dividends.
CN earned much less in the first quarter of 2018. The consensus recommendation of eight analysts is now ‘Hold’. We see the recent price setback as a buying opportunity. Both CN and CP have solid long-term prospects. That’s why we recommend you keep buying CN and CP.
In the first quarter of 2018, CN earned adjusted net income of $741 million, or a dollar a share. This was down by over 13 per cent from adjusted net income of $879 million. or $1.15 a share, a year earlier.
CN’s earnings growth will slow in 2018
In all of 2018, the market now expects CN to earn $5.17 a share. This was down from the previous estimate of $5.31 a share, a year earlier. This year’s estimate would mark earnings per share growth of just 3.6 per cent, from $4.99 a share last year.
CN’s lower earnings show up in the operating ratio (operating expenses as a percentage of freight revenue). It deteriorated by six percentage points, to 67.8 per cent.
One positive development is that CN raised its reinvestment to $425 million in the first quarter. This should help it overcome short-term challenges.
CN is doing other things right. It’s a ‘dividend aristocrat’ after raising its dividend each year since it was privatized in 1995. Growing dividends attract income-seeking investors, who bid up the shares.
The railway also rewards its shareholders by buying back its shares. In the first quarter, it spent $631 million repurchasing its shares. This exceeded buybacks of $491 million a year earlier. That’s why CN’s first-quarter earnings per share declined less than its total adjusted earnings per share.
CN is also the only railway to serve the port of Prince Rupert. This should give CN a competitive advantage for several reasons. For one thing, shipping to Prince Rupert can shave four days off the time it takes for Asian goods to land in North America. For another, the port of Prince Rupert is uncongested. Ports further south (such as Vancouver) often keep ships waiting for days before they can unload and reload. Then too, more freight is being shipped in intermodal containers (that ships, trains and trucks can all carry). The port of Prince Rupert is well-equipped to handle containers.
CN remains a buy for long-term share price gains as well as decent and growing dividends.
As we noted above, Canadian Pacific has become an icon of nationhood and celebrated in song by the likes of Hank Snow and Gordon Lightfoot among others. There are any number of YouTube videos of Hank Snow’s Canadian Pacific and Gordon Lightfoot’s Canadian Railroad Trilogy. Here are a couple you might enjoy. The montages are inspiring. Happy Victoria Day—It’s a shame she never got to see any of this.
Gordon Lightfoot’s Canadian Railroad Trilogy https://www.youtube.com/watch?v=Yzo6Otpgj-E and Hank Snow’s Canadian Pacific https://www.youtube.com/watch?reload=9&v=ZyeK4dfbth8
This is an edited version of an article that was originally published for subscribers in the May 4, 2018, issue of The Investment Reporter. You can profit from the award-winning advice subscribers receive regularly in The Investment Reporter.
The Investment Reporter, MPL Communications Inc.
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