Tags: Buffett | railroads | Canadian | CP

Play Railroads Like Buffett: Canadian Pacific

By Dan Weil   |   Monday, 10 Oct 2011 03:08 PM

Investing in railroads is sexy again, as illustrated by Warren Buffett’s hefty commitment to the industry. Buffett holding company Berkshire Hathaway bought railroad Burlington Northern Santa Fe last year for $26.9 billion. A similarly strong railroad play is Canadian Pacific Railway (CP), the second smallest of the major North American lines.

Railroads have been able to reap the rewards of deregulation, improving their efficiency and raising their prices. Canadian Pacific has 15,300 miles of track covering most of Canada and spilling over into the Midwest and northeastern United States.

Canadian carries an attractive mix of freight, including essential commodities such as grain, fertilizer, and coal. So-called “intermodal” containers (which can move from ship to rail to road quickly) accounted for 28 percent of the company’s revenue last year, compared to 23 percent for grain, 10 percent for coal, 10 percent for fertilizer, and 29 percent for a wide range of other products, according to Morningstar data.

Canadian Pacific suffered from bad weather earlier this year, but the company looks set to bounce back, with rate increases likely for much of its cargo. Canadian Pacific reported profit of $125 million in the second quarter, down 23 percent from a year earlier. Revenue rose 2 percent to $1.23 billion.

Operating leverage

Standard & Poor’s analyst Kevin Kirkeby has a four-star buy rating on Canadian Pacific shares. “Our buy recommendation reflects the favorable operating leverage we see embedded in CP's
network as it recovers from the significant weather disruptions experienced in 2011,” he writes.

“We think free cash flow growth will trail that of peers over the next three years due to a heavy
investment program, as well as rising pension contributions, despite gains in efficiency and
system-wide fluidity.”

Nonetheless, Kirkeby expects Canadian Pacific’s revenue to climb 2.7 percent this year in Canadian dollar terms, thanks to a 5 percent improvement in price and mix, partially offset by a 2.3 percent volume decline. The company next reports on Oct. 26.

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