January 24, 2017 - 5:38pm EST by
2017 2018
Price: 152.00 EPS 8.9 9.9
Shares Out. (in M): 147 P/E 17 15
Market Cap (in $M): 22,300 P/FCF 0 0
Net Debt (in $M): 8,500 EBIT 0 0
TEV ($): 30,800 TEV/EBIT 0 0

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I think CP is an interesting relative long, particularly against UPS as a short heading into 2017:

·         Management/messaging change

o   Hunter Harrison leaving is a negative, but this was widely known for a long time and I believe is discounted in the multiple

§  Keith Creel was his right-hand man and I believe he is very qualified and well-suited for the CEO role given my interactions with him

o   There have been two CFO changeovers in recent years, however my meetings with the current CFO (Nadeem Velani, formerly IR) suggest that:

§  I think the position has stabilized.  He was at CN with Hunter for 15 years before moving to CP 3 years ago and grew up with the current time in there (CEO now Keith Creel)

§  He knows what investors want and they have changed their messaging accordingly (overpromised and under-delivered all year this year)

·         Solid 2017 growth story

o   Ag

§  20-25% of CPs carloads come from grain, over half of which is Canadian grain

·         Unlike US grain shippers, Canadians don’t store nearly as much in hopes of better pricing

·         The Canadian crop was strong this year, but there was difficulty moving it due to record rains and snow throughout the winter

·         This grain will get moved in H117

§  5-6% of CPs carloads are from potash

·         The Canpotex deal with China didn’t get signed until Q316 and we saw a 12% sequential pickup in potash shipments from Q316 into Q4

o   This strength should continue into next year

·         Additionally, CP has exclusive rights to move K+S’s new potash mine that will be ramping in summer 2017, which is an incremental boost to volumes

o   International intermodal - ~20% of carloads

§  Nothing but conjecture here based on management’s past commentary, but Hunter took over in the middle of 2012 and really started showing operational improvements in 2013 and 2014…many of the international intermodal contracts are 3 years+ in length

·         It has been suggested that given how much better service has gotten over the last few years, some of CN’s business could flow to CP over time as their long haul intermodal offering moves product more quickly across country (travels over mountains vs. around them), yielding better service

§  CP’s international intermodal volumes accelerated throughout all of 2016

o   Crude – 2% of carloads

§  This has been a massive drag with volume down 50%+ for 2016, contributing 1-2% of CP’s -3% RTM growth number in 2016

·         At the very least, this should become less of a drag

·         With recent pricing developments due to OPEC production cuts and optimism over US industrial acceleration, it’s plausible that this could actually grow instead of just stabilize

o   Coal – 12% of carloads

§  >80% of CP’s coal carloads are for Teck Resources coking coal

§  While the coking coal price has retraced significantly from the record settlement over $300 (currently around $170), the price is still very attractive for producers

§  CP’s coal carloads have been much less volatile that US rails as coking coal is not subject to the same secular issues as thermal coal

o   Very easy 2017 comps, like most other rails

§  There were significant wildfires in Alberta which caused a significant miss in volumes in Q216 which the company will be lapping next year

§  As mentioned, grain volumes were held back by weather, causing easy H217 grain comps

§  Crude was down over 50% this year, which should improve in 2017

§  US coal should improve this year given the elevated natural gas price

§  Metals/minerals/frac sand was down DD most of 2016 until improving to close to flat in Q416

·         Solid growth story beyond 2017

o   CP benefits from USD strength vs. CAD

§  This hasn’t shown through yet, but many pundits suggest Trump’s policies will lead to a stronger USD

o   CP is one of the biggest beneficiaries of improved commodity outlook

§  CP is one of the largest bulk carriers as a % of revenues

§  The Canadian economy is a significant relative beneficiary to stronger commodity prices, particularly oil

o   CP’s service metrics are top notch and network is set up better for long-haul moves, which suggests potential continued share gain

o   While CP’s OR is better than the US rails, Hunter’s momentum in the franchise remains strong and there’s still another 500 bps or so to close the gap with CNI

·         Trump

o   Tax reform will be an incremental positive for CP, though obviously less so than US rails

o   NAFTA concerns are really centered more on outsourcing of jobs to Mexico than Canada, and while impossible to predict, management teams of the Canadian rails have reflected rather sanguine views on the risk

·         Valuation

o   CP is the cheapest of the class 1 rails (ex. KSU) by almost 2x across the board (17x 2017 earnings vs. every other name at 19x+)…I believe this is concern over Hunter leaving as well as recent poor execution on expectations.  They are also less of a beneficiary from whatever tax reform Trump gets through, which means current US rail EPS estimates are more understated.

§  It is also the cheapest relative to its historical range of up to 20x (18x is probably more appropriate)

o   I think going forward, CP has one of the best growth stories out of all of the rails, they are very strong executors, which suggests that there is continued bottom-line leverage that can come through and management tone around guidance has changed, which suggests upside to numbers

o   Current guidance is for HSD earnings growth with many of their segments showing inflecting growth into a much more commodity supportive year.

§  I think they should be able to grow earnings at least commensurate with the rest of the group, which suggests LDD growth

§  If they start executing on earnings consistently and showing revenue progression, I think the multiple can expand to at least 18x


·         This suggests upside to at least $175+ (15%+) on FY18

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.


Improved earnings execution

Volume inflection

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