17 October 2005
CN, CPR Gravy Train Rolls Along - With Caution
Call it the renaissance of Canada's two largest railways.
The share prices of Canadian National Railway Co. and Canadian Pacific Railway Ltd. have surged in the past 30 months, driven up by
huge Asian demand for Canadian commodities such as coal, grain, sulphur and forest products. As well, the railways have thrived on
delivering imported Asian consumer goods to Canadian retailers.
But the question now is how long will the party on the rails last? Analysts say it's not too late to hop aboard, although the
recommendations are accompanied by some cautionary notes.
CN releases its third-quarter financial results tomorrow, with the consensus profit estimate at $1.38 a share, according
to Thomson First Call. That's up from $1.19 a share in last year's third quarter.
David Newman, an analyst with National Bank Financial Inc., maintained his "sector perform" rating on
Montreal-based CN, but raised his 52-week target price to $90 from $80. Mr. Newman also likes
Calgary-based CPR, sticking to his "outperform" rating while boosting his 52-week target to $58
from $49.
CN shares rose 25 cents to $84.35 Friday on the Toronto Stock Exchange. CPR shares fell 13 cents to $49.45 on the TSX.
"The industry, led by CN, has undergone a renaissance with a renewed focus on customer service, coupled with increased
demand," said Mr. Newman in a research report titled "Steel Wheels Keep on Rollin".
CN has outpaced CPR in the past 30 months, with CN shares jumping 90 percent and CPR stock climbing 53 percent.
Investors have been impressed by CN's lower operating ratio - a key industry measure where operating expenses are divided by operating
revenue. CPR's higher ratio indicates that the company needs to better control its expenses and boost revenue, analysts say.
Many customers have chosen to move their goods by rail instead of hiring trucking firms, but the attention on recent derailments
threaten to take some of the shine off CN's financial performance in the third quarter.
"While derailments are a part of railroading, this quarter was especially difficult, with several high-profile train
derailments, most notably the Wabamun, Alta., derailment," Mr. Newman said.
Greater regulatory scrutiny of railway operating practices could lead to new rules curbing longer train lengths, analysts say.
"There are concerns about whether the trains are too long, but right now, it's not a major issue," said Research Capital
Corp. analyst John Chu in an interview.
For investors, the key is whether bustling Asian economies will slow down so much that it begins to affect CN, Canada's largest
railway, and CPR, the No. 2 player.
CPR will release its third-quarter results on 25 Oct 2005. CPR's consensus profit estimate is 89 cents a
share, up from 65 cents a year earlier.
Even if there is a slowdown in bustling Chinese trade, that's unlikely to spill over into the railways because the Port of Vancouver
is already congested, and the railways have to scramble to keep up with demand for their container services, Mr. Chu said.
"The ports aren't as jammed up as before, but they're still jammed up. And there's tight rail capacity," he said.
Mr. Chu kept a "buy" on CN, with a 52-week target price of $99, and he has a "buy" on CPR, with a
target of $55.
With strong demand for transporting goods by rail, and rail services in limited supply, that translates into "pricing power"
for the railways to maintain or even increase freight charges, analysts say.
As well, high diesel prices have hampered the railways to some extent, but they've lessened the pain with fuel surcharges and
fuel-hedging programs.
A tally of analyst recommendations by Bloomberg News shows 15 "buys" and eight "holds" on CN, while CPR garnered
15 "buys," three "holds," and one "sell."
Robert Fay, an analyst with Canaccord Capital Corp., said CN could post $1.40 a share in profit in the third quarter. But he cautions
that his CN estimate does not include the financial impact from Gulf Coast hurricanes or the derailment at Wabamun.
Despite such concerns, Mr. Fay upgraded CN to "buy" from "hold," and raised his 52-week target price
to $89.50 from $74. He maintained his "buy" rating on CPR while boosting his 52-week target price to $58.50
from $49.
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