Tag: CNR

CN Rail vs. CP Rail

This chart or post is not a value judgement on the respective companies, but it looks like that somebody playing the two-stock Canadian railroad industry should be shorting CN and longing CP:

CP Rail’s market cap at present is about CAD$10.1 billion, while CN Rail is at CAD$33.6 billion. In terms of profitability metrics, for the year ended 2010, CP had $651 million income, while CN had $2.1 billion income. Strictly in terms of backward looking P/E, they both scale equivalently which could justify the upper end of the price differential seen by both companies historically.

CN Rail or CP Rail – A look at the Railways

People trying to get on board the Warren Buffett bandwagon and are too cheap to purchase a Class A share of Berkshire Hathaway (currently $129,538/share) to participating in Burlington Northern are looking at other publicly traded rail options.

These include the following American names:
CSX (NYSE: CSX) – Eastern USA, competes with NSC
Kansas City Southern (NYSE: KSU) – Mid-Southern USA and both sides of Mexico
Norfolk Southern (NYSE: NSC) – Eastern USA, competes with CSX
Union Pacific (NYSE: UNP) – Primarily competes with Burlington Northern

In Canada, there are two majors:
CN Rail (TSX: CNR) – Very large network from Prince Rupert and Vancouver on the Pacific to the St. Lawrence River and Halifax to the Atlantic and New Orleans to the Gulf of Mexico.
CP Rail (TSX: CP) – From Vancouver to the St. Lawrence River.

The railways trade at roughly the same valuations – very roughly, around 16-20 times earnings, depending on the company. There are reasons for these earnings differentials, mainly balance sheet factors.

Comparing CNR and CP, CP rail appears to be a tad cheaper right now, but both are relatively expensive for what you are purchasing – a utility-type company that will continue to be very profitable in the future as energy prices increase. They will once again decrease in valuation when the physical amount of goods in the economy slows down, like things did in the second half of 2008.

Although both companies are well run and profitable, they are classic examples of such companies that you would not want to invest in unless if you wanted to invest a huge amount of money in them for the purposes of stability. Even then, one would think that waiting for the next recession would give you a better entry point.

The difference between ocean and land freight transportation

Apparently ocean freight rates for various commodities are tumbling simply because of the supply of vessels available to transport such goods.

I know very little about the ocean freight industry other than that internationally based companies, such as Dryships (Nasdaq: DRYS) have exhibited considerable volatility as the market has boomed and now crashed.

The big difference between ocean shipping and land shipping is that inexpensive freight transit can only be performed by railways, while oceans are only limited by the number of ships you can manufacture and port facilities. Trucking is not commercially competitive with rail freight (except for delivery to the “last mile”) and as energy prices continue to rise, rail will continue to be very relevant in the future.

The two large Canadian companies in this space are CN Rail (TSX: CNR) and CP Rail (TSX: CP), both of which are trading at healthy, but not ridiculously overpriced valuations.

The CN Rail Cash Machine

CN Rail reported their Q3-2010 result; it indicates they have recovered well from the economic crisis.

Although CN’s equity price is relatively high in terms of the cash they are able to deliver to shareholders (most notably they are spending about $300M/year above the rate they are amortizing), there are worse places to put “stable” cash – the equity trades more like a bond. This is another example of when people talk about “asset classes” that you cannot just put a blanket on “Canadian equity” and consider every share of every corporation to have the same risk/reward characteristic.

In terms of the actual numbers, the business was able to generate about $2.78 per share of free cash flow over the past 9 months. Annualized, this is about $3.71 in free cash, on top of a $67 equity price justifies the “relatively high” remark with respect to valuation.

Despite the high price (which is very near all-time highs), it is likely that CN’s total return over the next 10 years will outperform the equivalent Canadian 10-year bond, which yields 2.74%. The railways (CN and CP Rail) will likely be successful cash generating entities as long as Canada and the USA remain politically stable, and also are a benefactor of high energy prices – freight rail competes very well against trucking when it comes to goods movement.

Unlike most utilities, all railways have one very valuable piece of paper which is impossible to obtain – the right of way in major urban centres. If you were to give somebody $100 billion from scratch and got them to construct a railway, there is no way you could transform that capital into an income-bearing instrument that would yield better than the government bond. One of those reasons is property acquisition and track right of way – something Warren Buffet was thinking about when he bought out Burlington Northern. The only way you’d be able to get any sort of reasonable return is just to buy the railway outright, but even then the government could step in, citing “national interests”.