Morningstar | CP's Operating Ratio Hammered by Weather and Network Shocks, Expect Full-Year Recovery. See Updated Analyst Note from 24 Apr 2019
We expect wide-moat Canadian Pacific Railway to recover to a strong sub-60% annual operating ratio during 2019 despite a rough start because of a harsh winter and a tragic accident that slowed the mainline. We are increasing our fair value estimate slightly because of the time value of money and to better reflect the strong pricing in the rail segment during the period, in our valuation model. Management described same-store pricing improvements as near the high end of its 3%-4% expectation, and consolidated revenue per revenue ton mile increased at a strong 7% year over year (4% on a currency normalized basis). First-quarter revenue ton miles declined 1% and carloads dropped 2%, but the rail segment grew revenue 6%, EBIT 1%, currency-normalized EPS 3%, and currency-normalized free cash flow 18%.Management expects mid-single digit revenue ton-mile growth and double-digit growth in normalized earnings per share. CP grew its energy, chemicals, and plastics segment revenue 18% (Foreign exchange adjusted) year over year, following strong LPG, plastics and refined products shipments. This was the only main segment with material carload growth this period (6%), and carloads declined in most segments.
As in other segments, intermodal volume was constrained because the network was hampered by harsh weather, but in March CP reached new high water marks for domestic intermodal revenue and volume. The international segment also seems strong, given management’s indication that second quarter to date volume is up 15%.
Our expectation CP will lead the railroad firms in profit margins, matched only by CN, is not shaken by a harsh winter nor one quarter of an unflattering 69.3% operating ratio. This is a reasonable possibility for this rail segment, given its locale, and outdoor conditions can hit transport segments. This needs to be within expectations for railroad investors, particularly during calendar first quarters, when North American winter storms are at their worst.
We were a bit surprised by the 10% growth in auto revenue ton miles during the period and CP has opened two auto compounds (including one in March) to attract greater volume to its network even amid a broadly plateaued industry volume. One CP-served plant builds the Toyota RAV-4, a strong seller in the North American market that prefers light trucks to sedans.
Canadian Pacific Railway operates a transcontinental railway in Canada and the U.S. Co.'s business mix includes bulk commodities, merchandise freight and intermodal traffic, serving the principal business centers of Canada from Montreal, Quebec, to Vancouver, British Columbia, and the U.S. Northeast and Midwest regions. As of Dec 31 2016, Co. operated on a network of approximately 12,400 miles of track, of which CP owns 10,800 miles and has access to 1,600 miles under trackage rights and lease agreements. Of the total mileage operated, about 5,600 miles were located in western Canada, 2,000 miles in eastern Canada, 4,400 miles in the U.S. Midwest and 400 miles in the U.S. Northeast.
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