Monday, November 17, 2008

new position - CP Rail

Today I initiated a new position within my non-registered portfolio in Canadian Pacific Railway (CP) at $39.94. CP is a transcontinental railway that transports bulk commodities, merchandise freight, and intermodal traffic.

Why A Railway?
One of the most compelling reasons to invest in a railway is the fact that by their nature they possess incredibly high barriers to entry. What is meant by this is that railways and the rail industry have characteristics that act as barriers to other potential competitors entering. How many North American entrepreneurs will have the desire to build a cross country railroad anytime soon?

Other attractive features of investing of railways include their fuel efficiency vs. trucking (1/4 cost advantage), hauling coal over long distances belongs to the rails, increased trade with Asia mean longer distance runs, truck driving hour regulations, innovations like double stacked and computer guided cars are making rail even more competitive with trucking. Thanks to the monopolistic nature of railroads they also have serious pricing power.

Why Canadian Pacific (CP)?
  • Canadian dividend tax credit makes CP more attractive for me than U.S. names
  • Canadian National Railway (CNR) is a much more expensive stock

Why Now?

I've wanted to own a railway for a few years now but I have never been able to justify a purchase based on the richness of the stock valuations. CNR and CP have traded well over 12x earnings for much of the last few years as the economy grew at a reasonable pace. Now that economic activity and commodity prices have really started to sputter, so has CP's share price. Here are the specifics that really got me interested:

  • P/E ratio of 8x earnings
  • Dividend yield of 2.5%
  • Price to Book ratio of 1.1x
  • Dividend Payout ratio is under 15%
  • Return on Equity is 18%
  • Stock last traded at these levels in early 2005

Compare these numbers with CNR, and the two stocks are not even in the same rail yard as far as valuations go.

I really like the idea of owning CP for the long term because this railway is really tied into Western Canadian commodities, including agriculture, while at the same time the company by nature should experience much less volatile earnings than an actual commodity producer would. CP is an extremely boring business that should continue to stay on "track" with growing long term earnings and dividends.

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Potato said...

I've got the railways on my watchlist, too, but haven't nibbled yet. I've got a preference for the name CN has, but like you said, it's not quite as cheap as a result.

"How many North American entrepreneurs will have the desire to build a cross country railroad anytime soon?"

Oh, oh! I'm all about building railroads, and mine will be all crazy modern and mag-lev and electrified and fast!! ...I'm just having a teensy problem with finding financial backing at the moment...

MG (moneygardener) said...

Good luck with that Potato. I think you should add a monorail and hire Homer Simpson while you are at it.

Million Dollar Journey said...

Good buy MG. I've also got my eye on CNR and CP, and have made the same conclusions that CP is much cheaper at the moment. Do you know why the market is selling off CP more aggressively than CNR?

Thicken My Wallet said...

I love railways and have them on the watch list. Like you, I find them expensive stocks but there is a predictability to them.

I do like CN better though. Better operating efficiencies and a more extensive network into the U.S. but it is premium priced for that reason.

Good luck with the purchase.

MG (moneygardener) said...

FT, CNR should always be a more expensive stock because they are more efficient and have a better dividend and earnings growth track record. They should also be more stable as they are less tied to commodities. That being said the valuation gap between these two has grown much too wide in my opinion. CP has likely sold off to this extent because it is veiwed more as being tied to commodities and activity there is falling.

Dividend Growth Investor said...


How well is the annual interest expense covered by earnings for these railways?
I have been thinking about CNR, but I am not sure whether transportation stocks will be good dividend growth plays if they turn out to be cyclical in nature..

MG (moneygardener) said...

DGI, Interest coverage for CP is roughly 6.0. They should be cyclical, but I believe the nature of their business protects them more on the downside than some other industries.

Anonymous said...

I am somewhat confused how one can say that CNR is so much more expensive. I am very new to this, but when I look at the cash flow per share of these two companies, CNR comes out WAY ahead. If one believes they are purchasing the future cash flow of a company when buying shares (Mr Buffett), it would seem to me that CNR is a better buy at these prices....Price/cash flow of CP is 9.8...CNR is 5.2 Roughly half the price for the same cash flow... What am I missing? I have yet to do a DCF analysis or anything like that yet, but just looking at that valuation, I would choose CNR before CP... Someone straighten me out please.

Anonymous said...

OOOpppps...disregard that previous comment. It always helps to move your finger across the chart properly. I see now that CNR is twice the price/cash flow of CP. Now I get it. Sorry about that

MG (moneygardener) said...

CNR's price/book is 2.1
CP's price/book is 1.1

CNR's price/earnings is 10.0
CP's price/earnings is 7.8

CNR's price/cash flow = 7.4
CP' prcie/cash flow = 5.1

There are many ways to value stocks but it is hard to argue with price to book for a rail company. Cash flow and earnings are so unpredictable going forward that they are a weak measure anyway.

Nancy (aka money coach) said...

This was a fun read, as about 5 years ago I faced the same dilemma and opted for CN. My reasoning then (and the difference was not nearly as stark) was that CP was laying track in China, while CN secured the rights to Prince Rupert. China was just a little dicey to me, whereas P.R. is much safer, although if the economy tanks, it may not be the port city we all thought it would become.

Anonymous said...

CP is a decent rail, but CNR is far better managed and has a better should always before expensive.

Interestingly 6-12 months ago it was actually more expensive on a P/E basis, and so took a much bigger fall down during the last market assault.

While it is cheap, I would stick with CNR...over the decades CP management just hasnt proven themselves (kinda like Petro Canada...always second fiddle).

Anonymous said...

I second that.

Look at CNR's fat margins:

Compared with CP's: