Canadian Pacific Turns in Solid Execution

Canadian Pacific (CP) executed well on decent 4% third-quarter revenue ton mile growth, and raised its guidance to double-digit EPS growth for the full year, an increase from prior high-single-digit percentages guidance over the adjusted 2016 value of CAD 10.29. We’ve tuned our model to match actual performance, but because results don’t differ much from our projections, we anticipate any fair value change will be upward and minor. The guidance bump is a bit more impressive than it might sound at face value because the increase comes despite currency headwinds and the acknowledgment that CAD 45 million of previously anticipated property sales will likely not materialize in this calendar year. We maintain our wide moat rating.

CP continues to meet our expectations of profit margins close to its best-in-class neighbor, Canadian National. Looking forward, CEO Keith Creel asserted that in 2018 a mid-50s operating ratio is a “very reachable number,” even excluding land sales. We model 57% in 2018 and continuing improvement over the next four years, due chiefly to labor efficiency gains.

Persistent and heavy capital expenditure demands are a hallmark of the railroad industry, and CP is no exception. Most capital expenditure (60%-70%) is for maintenance, but CP mentioned an investment designed to smooth intermodal drayage: It is installing automatic gate equipment at all intermodal terminals, coupled with a mobile application to manage truckers’ container pickup or drop-off incidents. We believe intermodal is the secular volume driver at the rails, and investing to support this growth will remain a locus of growth capital investment.

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