Canadian Pacific Railway Ltd. $70 - Toronto symbol CP

CANADIAN PACIFIC RAILWAY LTD. $70 (Toronto symbol CP; Conservative Growth Portfolio, Manufacturing & Industry sector; Shares outstanding: 153.1 million; Market cap: $10.7 billion; SI Rating: Above average) transports freight over a rail network between Montreal and Vancouver. In the United States, subsidiaries connect CP’s Canadian lines to major hubs in the Midwest and Northeast. Alliances with other railways extend its reach to Mexico. CP’s revenue rose from $3.7 billion in 2002 to $4.6 billion in 2006, largely due to the expansion of trade with Asia. Profits fell from $3.06 a share (total $487.5 million) in 2002 to $2.52 a share ($401.3 million) in 2003 due to higher fuel costs. The company began charging its customers a special surcharge to cover its extra fuel costs, and profits improved to $5.02 a share ($796.3 million) in 2006. If you disregard unusual items, CP would have earned $3.95 a share in 2006. Goods hauled include consumer products (28% of total revenue in the first half of 2007); grain (20%); industrial parts (14%); coal (13%); fertilizers (12%); automotive goods (7%); and forest products (6%). This wide source of revenue cuts CP’s reliance on any single industry or commodity. Despite rising transportation costs, more shippers are turning to railways instead of using trucks. That’s because rail is the most efficient way to move large volumes over long distances. Trains can also pass more quickly through border inspection stations, while new terminals inside big cities bring trains closer to customer warehouses. Thanks to growing awareness of the importance of railways, CP is finding it easier to raise prices and still hang on to customers. In the second quarter of 2007, a 4.5% rise in prices helped CP’s total revenue grow 8.0%, to $1.22 billion from $1.13 billion a year earlier. Income before unusual items rose 8.7%, to $175 million from $161 million. Per-share income grew 12%, to $1.12 from $1.00, due to fewer shares outstanding. Despite bad weather and a 26-day strike by its maintenance workers, CP cut its operating ratio (regular operating expenses divided by revenue — the lower, the better) to 74.7% in the latest quarter from 75.0% a year earlier. Better scheduling and faster train speeds should let CP keep its operating ratio under 75% for all of 2007, while maintaining its status as the safest railway in North America. CP will probably spend $5.80 a share on capital upgrades in 2007, up 15% from $5.05 in 2006. Most of the increase will go towards new fuel-efficient locomotives, and to increase capacity. CP will also build a new line to service a new Toyota plant in Ontario. The company should generate $8.60 a share in cash flow this year, so it can comfortably afford these outlays. CP is also using its strong cash flow to buy back 10% of its outstanding shares. That could cost it $1.2 billion. However, the company had just $392.1 million ($2.56 a share) at June 30, 2007. Sales of surplus real estate, such as a recent deal to sell its Montreal station, should help give CP the cash it needs for the buyback. The company’s long-term debt of $3.05 billion is a reasonable 0.6 times equity, so it has plenty of room to borrow more cash if needs to. CP should earn $4.43 a share before unusual items in 2007, and the stock trades at 15.8 times that estimate. Earnings could rise to $5.10 in 2008, which implies a p/e of just 13.7. The $0.90 dividend yields 1.3%. CP Rail is a buy.