This long-established transportation firm continues to upgrade operations while it invests for the future.

Investments in new equipment and improved software help the company deal with rising fuel costs and shipments curtailed by bad weather. It has also dealt swiftly with labour problems. In the meantime, the upgrades are pushing up revenue and earnings, while the company raised its dividend by 15.5%.

CANADIAN PACIFIC RAILWAY LTD. (Toronto symbol CP; www.cpr.ca) transports freight over a 22,000-kilometre rail network between Montreal and Vancouver, and to hubs in the U.S. Midwest and Northeast.

Shipping bulk commodities such as grain, coal, potash and fertilizers, supplied 44% of CP’s revenue in 2017. Merchandise such as automotive equipment, metals, consumer products and forest products accounted for a further 35%. The remaining 21% came from intermodal traffic, which consists of containers that travel by rail, ship and truck.

CP’s revenue rose 9.4%, from $6.1 billion in 2013 to $6.7 billion in 2015. However, revenue fell 7.2% to $6.2 billion in 2016. That decline was largely because producers of commodities such as oil, potash and minerals shipped less of their products in response to lower selling prices. Revenue rose 5.2% to $6.55 billion in 2017 on stronger volumes of fracking sand, crude oil, chemicals and plastics, domestic intermodal, potash and Canadian grain.

Overall earnings jumped 43.6%, from $1.1 billion in 2013 to $1.6 billion in 2015. Due to fewer shares outstanding, earnings per share rose at a faster rate of 57.3%, from $6.42 to $10.10. Due to the drop in revenue, CP’s earnings in 2016 fell 4.7% to $1.5 billion, but earnings per share rose 1.9% to $10.29 on fewer shares outstanding. Earnings recovered 7.6%, to $1.7 billion in 2017, while earnings per share gained 10.7% to $11.39.

Better efficiency is the main reason behind CP’s higher earnings. In the past few years, the company has invested heavily in new locomotives, tracks and software that optimizes train loads and speeds.

Thanks to those outlays, CP’s operating ratio improved from 69.9% in 2013 to 58.2% in 2017 (Operating ratio is calculated by dividing regular operating costs by revenue. The lower that ratio is, the better.)

Blue Chip Stocks: Dividend raised by 15.5% with room for more increases

In May 2018, CP’s conductors and electrical workers went on strike. However, the company and the two unions involved quickly agreed to new contracts.

Due to that disruption, CP’s earnings in the three months ended June 30, 2018, fell 9.2%, to $436 million from $480 million a year earlier. With fewer shares outstanding, per-share earnings declined at a slower rate of 7.0%, to $3.16 from $3.27.

If you disregard unusual items, earnings per share improved 14.1%, to $3.16 from $2.77.

In the quarter, revenue rose 6.5%, to $1.75 billion from $1.64 billion a year earlier. That also exceeded the consensus forecast of $1.73 billion. Most of the higher revenue came from shipping oil, metals, minerals, grain, potash and automotive products. Those gains offset declines in coal and fertilizers.

However, due to the strike and higher labour costs, CP’s operating ratio in the quarter worsened to 64.2% from 62.8% a year earlier. Without those disruptions, its operating ratio would have remained unchanged.

CP recently ordered 1,000 new railcars for shipping grain (called “hoppers”). It expects to receive 500 of those cars by the end of 2018. This initial order is part of CP’s larger plan to purchase 5,900 hopper cars over the next four years.

The company is upgrading its hopper fleet in response to new federal regulations that encourage railways to replace older government-owned cars with new models. As well, the new hopper cars will let CP cope with rising grain volumes and speed deliveries.

As a result of the new hopper cars, CP now expects to spend $1.55 billion on upgrades and new equipment in 2018. That’s up from its earlier forecast of $1.35 billion to $1.50 billion.

The company’s strong balance sheet will let it keep investing in its operations. As of June 30, 2018, its long-term debt of $7.9 billion is a moderate 21% of its market cap. It also held cash of $51 million.

Moreover, CP recently refinanced $500 million U.S. of its outstanding bonds. The move should lower its annual interest costs by $20 million. The company also plans to sell $50 million of surplus land later this year.

Thanks to its improving outlook, CP raised its quarterly dividend 15.5% with the July 2018 payment. Investors now receive $0.65 a share instead of $0.5625. The new annual rate of $2.60 yields 1.0%.

CP should generate free cash flow (regular cash flow less capital expenditures) of $1.15 billion in 2018, up 30.0% from $887 million in 2017. Even after this latest increase, dividends for all of 2018 would likely total $348 million, so there’s plenty of room to keep increasing the dividend rate.

The stock hit a new all-time high of $277.25 on September 6, 2018, but has moved down since then. For all of 2018, the company should earn $13.18 a share. The stock trades at 20.4 times that forecast. Earnings in 2019 could reach $14.80 a share, and the stock trades at a more reasonable 18.4 times that forecast.

Recommendation in The Successful Investor: CP Rail is a buy.

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