It’s been a hard winter for railways, but Raymond James analyst thinks this stock is ‘now on sale’
While Canada’s railways grapple with operational issues and a grain backlog that has infuriated many farmers, one analyst has selected Canadian Pacific Railway as the preferred railroad and upgraded its target price.
Raymond James Ltd. analyst Steve Hansen increased the target price for CP from $255 to $260 on Tuesday, saying the railway was preferred over Canadian National Railway Co. “given its attractive growth profile, solid relative execution and attractive valuation.”
“While spring’s imminent arrival will undoubtedly help both carriers improve their service levels… we’re inclined to believe that CN’s acute service challenges had a lasting impression on many key customers — one that will likely translate into new contract opportunities for CP as customers reassess their shipper concentration,” Hansen wrote in a note to clients Tuesday.
“Coupled with the firm’s sizeable crude-by-rail opportunity… and attractive macro backdrop, we believe this incremental shift in contractual volumes will help underpin CP’s attractive growth outlook.”
The company’s stock was trading at $242.42 per share on the Toronto Stock Exchange on Tuesday.
CN and CP have faced government scrutiny and backlash from customers over operational issues and significant delays that have caused a backlog in grain shipments. Both railways have cited harsh winter weather, combined with largely unexpected increased demand, as major factors contributing to the delay. CN’s stock has fallen 9.7 per cent since the start of the year, while CP has seen a more moderate decline of 2.3 per cent.
Last month, the U.S. Surface Transportation Board issued letters to the chief executive officers of major North American railways demanding a service outlook for the remainder of 2018 after it received complaints about poor service from two major rail shipper trade associations.
In a letter submitted to the SFB, the U.S. National Grain and Feed Association listed six issues with CN’s service, among them that the company’s problems are “systemwide” with some companies reporting that 100 loaded cars have been waiting to be pulled for between four and six weeks. It cited one issue with CP, saying that significant delays of eight to 10 days during the last 45 days of 2017 have led to increased dwell times.
Appearing before the federal government’s Standing Committee on Agriculture and Agri-Food in late March, executives from CN and CP reiterated that they are taking steps to alleviate the backlog.
CN, which saw its former chief executive Luc Jobin step down amid growing complaints about its service, has apologized for the backlog on numerous occasions and committed to spending more on infrastructure and locomotives.
“By almost all accounts, winter has been hard — really hard — but it is stubbornly passing,” Hansen wrote.
“While CN and CP both face acute operational headwinds during 1Q18 (CN in particular), we believe the worst of these challenges are poised to fade — a seasonal transition that will undoubtedly allow both carriers to improve service levels and better capitalize on the attractive macro backdrop.”
Hansen also said that the challenges brought by harsh winter weather were compounded by a range of factors, including better-than-expected traffic growth, and CN’s existing congestion issues that emerged in the fall and left the company vulnerable over the winter.
At the same time, Raymond James reiterated the $110 target price for CN, saying that a the stock’s recent drop of nearly 10 per cent since 2018 “largely accounts for the operation challenges” the company has been facing. The company was trading at around $94 per share on the Toronto Stock Exchange.
“In short, great companies like CN rarely go on sale. When they do, we like to act,” Hansen wrote.
“To be clear, we expect many of CN’s recent congestion issues to linger until key infrastructure bottlenecks are addressed… Still, we believe the operational trajectory is likely to improve vs. recent levels, a trend that should help bolster the firm’s fundamental outlook through the balance of 2018.”
Hansen also noted that he expects operating ratios — a key industry metric that measures expenses as a percentage of revenues — will increase at both railways in the first quarter, due not only to winter challenges but changes in pension accounting rules.
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