Canadian Pacific president and CEO Fred Green - Date unknown David Bloom.

28 March 2012

Was CP Rail Investor Day Enough?

Toronto Ontario - While Canadian Pacific Railway Ltd. may have made some sound arguments at its investor day in Toronto this week, some questioned whether it would be enough to sway shareholders.
 
Fred Green, CP chief executive, and several members of the board came out swinging at the meeting with analysts, investors, and media, in particular, attacking the reputation of Hunter Harrison, the former CEO of rival Canadian National Railway Co., who has been put forth as a potential replacement for Mr. Green by activist investor Bill Ackman and his Pershing Square Capital Management L.P.
 
But whatever reputation Mr. Harrison had in the industry pales to the operating performance he had at CN and other railways, said Tom Wadewitz, JP Morgan analyst, in a note to clients.
 
"CP's management and several members of the board repeatedly presented a view that Hunter Harrison would be bad for the company," he said. "Given Hunter's stellar track record at both Illinois Central and CNI, we believe this argument is not credible."
 
Mr. Wadewitz also took issue with some of the claims made by third-party consultancy firm, the Oliver Wyman Group, that Mr. Harrison's goal of achieving a 65 percent operating ratio by 2015 is not possible, and that there are inherent structural differences at CP that intrinsically add 6.7 percent to its operating ratio relative to its rival, CN.
 
He said he suspected the analysis overstated the structural differences between the railways while understating the advantages CP have from a larger bulk business, which comes at a lower cost.
 
Mr. Wadewitz took issue with Oliver Wyman's assertion that achieving an operating ratio of 65 percent by 2015 was "not possible" in that timeframe.
 
He said CP would only have to achieve a 316 basis point improvement annually over the next four years to achieve that goal from 2010 levels, which were a more normal reflection than in 2011 when the network was plagued by avalanches and floods.
 
He noted that other railways, including CN, have achieved improvements of between 245 and 279 basis points annually in the past.
 
"While this is greater than the pace realized at the other railroads, the difference is only modest compared to these periods when other railroads were following trends of strong improvement," he said.
 
He added:  "In our view, investor support for Hunter Harrison and management change is very strong and we believe that CP faces an uphill battle in the proxy fight."
 
Christian Wetherbee, Citigroup Global Markets analysts, said CP made some good arguments by refuting Pershing's operating metrics and unit cost comparisons and defending its own capital plan. But, ultimately, he questioned whether it would be enough to persuade shareholders not vote for its plan.
 
"We believe there is some merit in CP's argument that Pershing Square is at a disadvantage in forecasting operating ratio targets as it does not have asymmetrical information," he said. "That said, in our view, Pershing does not necessarily need to present a turnaround case with extensive detail, as it holds the clear advantage of Hunter Harrison's strong Illinois Central and CN track records.
 
David Newman, Cormark Securities analyst, said his concern was that it was the current management team under Mr. Green that developed multiple iterations of the same plan over the past five years, and "realized a sudden epiphany when pressured by an activist shareholder and could settle into the zone of comfort after the initial flurry to win over investors."
 
He said the use of investor funds to hire a Oliver Wyman to validate its under performance and "scripted Q&A" session "likely amplified investor concerns."
 
"Pershing's plan, with Hunter Harrison as its centrepiece, is aggressive, perhaps not realistic, but we believe this to be a vote for execution," he said in a note to clients.
 
Scott Deveau.