Canadian railways are on track to deliver profits
By
Senior Writer
Eoin Gleeson
Aug 15, 2008
More and more Americans are turning to Amtrak
A commuter revolution is underway in America. Sick of filling their tanks for $4 a gallon only to crawl to work on heavily congested roads, over 2.5 million people (more than at any time in the last 30 years) rode the Amtrak in June. Indeed, local transit systems from Washington to California scrambled to add new trains to meet passenger demand, says Jay Palmer in Barron's.
It's a glimpse of things to come – rail is the future of transport for countries like America. First, there's fuel efficiency. Commuters might return to their cars in the short-term as the price of petrol drops off, but America can't continue to ship such large volumes of its goods by truck. Transport groups are already switching to rail, which provides a cheap alternative to road freight. One standard railcar can hold up to 100 tons of densely-packed freight. To ship that much by truck would take four standard tractor-trailers and four times as much fuel, says InvestmentU's Alexander Wissel.
Rail's second advantage is that it gets around the congestion problem that's bringing major cities to a standstill. Rail unclogs the roads and gives planners back a bit of urban space. Finally, there's coal. Railroads carry more than 65% of America's coal, which provides more than half of the nation's electricity. With demand for electricity expected to double over the next two decades, that's a lot of coal to shift. The Department of Transportation predicts freight rail tonnage will rise 90% by 2035.
Small wonder investors are convinced that US railroad stocks are immune to the economic downturn – the average railroad stock trades on a forward p/e of 19.8. But investors are looking too far along the tracks. The industry faces several problems that make these valuations look overly optimistic. For example, one thing that has boosted freight volumes over the last few years has been Chinese imports. Railcars offloading coal in California carried Chinese shoes and toys on the return to Chicago. Clusters of warehouses sprung up along the Transcontinental route in Texas and Illinois. But there will be far fewer Chinese shoes and toys stacked on the shelves of Wal-Mart this year, leaving those warehouses empty. And it's not just Chinese imports. Ethanol, car parts, timber – many of the industries that have boosted rail traffic in recent years are suffering as the economy slumps.
Canadian rail firms, on the other hand, benefit from shipping potash fertiliser and oil from the Canadian tar sands. With drought, desertification and changing diets wiping out farmland globally, demand for fertiliser is soaring. The cost of producing it is rising, but the three Canadian potash groups that collectively make up the world's largest potash exporter recently announced plans to double capacity on the West Coast. New terminals in British Columbia and Vancouver are likely to come on line in 2012.
The expansion is liable to be split evenly between the two major Canadian railroaders – Canadian National Railway and Canadian Pacific Railway, says RBC Capital Markets analyst Walter Spracklin. And as David Powell of Matisse Capital Management points out, with oil sands production expected to triple to three million barrels a day over the next ten years, there is a lot more than just coal and corn to the Canadian rail story. We have a look at one Canadian railroader set to profit below.
The best stock in the sector
Since we last tipped railroad stocks, Norfolk Southern has risen 30% (from our tip in April 2007) and railcar manufacturer Trinity Industries has jumped 60% (from January 2008). Now would be a good time to take profits if you bought either of them. But Canadian National Railway (NYSE:CNI), which maintains the highest margins in the business, remains an attractive buy.
As David Powell of Matisse Capital Management points out, if the oil sands are to produce three million barrels a day within the next ten years (and the oil price would have to fall a lot further than we think it will before the sands became uneconomical), it will need rail support from Canadian National, the dominant railroader with a network in the area. The firm's 20,400 route-mile network also extends to potash mines, coal mines and corn distribution centres in Canada and America.
Yet the group is trading on a forward p/e of just 13.3 times, compared to the industry average of 19.8, according to Morningstar. Certainly, just as timber (20% of CNI's revenues) and automotive shipments have fallen in the States, Canadian National's freight has declined in these areas. But the company can still expect a 16% jump in earnings per share from this year to next. Odlum Brown analyst Stephen Boland maintains a C$65 price target for the stock, a 25% upside.
Published in Stock markets
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by
Eoin Gleeson
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