Buy railway stock CP as it earns record profits

Canadian Pacific Railway is expected to earn record profits again, both this year and next. It has resumed raising its dividend, though it yields little. This transportation and logistics stock remains a buy for long-term share price gains as well as small, but growing, dividends.

Railway StockCalgary-based blue chip stock Canadian Pacific Railway (TSX—CP; NYSE—CP), reported its earnings for the first quarter of 2017. It’s expected to earn record-high profits this year and next. The transcontinental railroad remains a buy for long-term share price gains and small dividends that have resumed growing. (Just remember that rival and ‘best buy for growth’ Canadian National Railway (TSX—CNR; NYSE—CNI) is winning more new business than CP.)

In the three months to March 31, CP earned $368 million, or $2.50 a share, excluding one-time items in both periods. This was unchanged from 2016 Q1 earnings of $384 million, or $2.50 a share.

CP’s earnings per share remained stable despite lower total earnings. That’s because it bought back shares. On March 31, the railroad had a weighted average of 147.1 million diluted shares outstanding. That’s down by 6.7 million shares, or 4.4 per cent, from the year before.

Management is “cautiously optimistic”

Even though the earnings per share remained the same, president and chief executive officer Keith Creel is upbeat. He said: “We turned a corner in March and are now seeing positive volumes, which makes us cautiously optimistic that the demand environment is improving.” Specifically, Mr. Creel has “a great deal of confidence that we’ll be able to deliver high single-digit adjusted diluted EPS [earnings per share] growth in 2017”. We believe that Mr. Creel is right to be “cautiously optimistic”. That’s because CP and North America’s transportation industry face risks.

Will U.S. president Donald Trump disrupt NAFTA?

One risk to CPR and CNR is if the U.S. implements a ‘border tax’. That would reduce exports and the need for rail service.

On the positive side, the global economy is growing more quickly. China—Canada’s second-largest trading partner—is growing faster than originally expected. Railroads, in particular, profit from trade with Asia. Freer-trade agreements with the European Union and South Korea could soften the blow of potentially lower exports south of the border.

The integration of continental production means that disrupting these supply chains could destroy many jobs in all three NAFTA (North American Free Trade Agreement) countries. The Trump administration may back down if it faces significant ‘pushback’.

Operating ratio has improved

CP reported that its operating (or cost-to-revenue) ratio improved by 0.9 per cent, to 58.1 per cent. But this was partly due to a “management transition recovery of $51 million related to the retirement of E. Hunter Harrison as CEO [chief executive officer] of CP”. Remove one-time items and the railroad’s adjusted operating ratio deteriorated by 2.4 percentage points, to 61.3 per cent (lower is better). This was worse than its operating ratio of 58.9 per cent a year earlier. Mr. Creel refers to CP’s “disciplined cost control”. This could improve its operating ratio.

CP paid dividends of $1.40 a share from 2013 through 2015. Since then, however, it has raised its dividends. In 2016, the railroad paid $1.85 a share. In 2017, it’s set to pay dividends of two dollars a share. Growing dividends are a positive indicator. The main drawback is that the dividend yields a small 0.97 per cent. If you need dividend income, you can do better with other companies, including its fellow blue chip stock and competitor Canadian National Railway.

Record profits expected this year and next

In 2017, CP’s earnings are expected to climb by 12.7 per cent, to a record $11.60 a share. Based on this estimate, the shares trade at a reasonable price-to-earnings, or P/E, ratio of 17.8 times. Next year, the railroad’s earnings are expected to advance by 12.2 per cent, to a new record of $13.01 a share. Based on this estimate, the shares trade at a better P/E ratio of 15.9 times.

The consensus recommendation of six analysts is that CP is a ‘buy’. We agree. CP remains a buy for long-term share price gains as well as small dividends that have resumed growing.

This is an edited version of an article that was originally published for subscribers in the May 5, 2017, 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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