Monday, September 24, 2012

CP, “The last great rail turnaround”

Written by 

Wall Street analyst William Greene of Morgan Stanley Research
North America is telling investors in the rail sector that Canadian Pacific Railway, under the direction of newly appointed chief executive E. Hunter Harrison, “could be the most compelling railroad investment opportunity for the next three years.”

“We are resuming coverage of CP at Overweight and adding it to Morgan Stanley’s Best Ideas list,” says Greene. “CP is one of the cheapest rails on 2014 and 2015 growth. While CP looks expensive on current sell-side consensus, we believe consensus significantly underestimates the pace at which CP can improve margins and earnings. The stock is cheap on a price/earnings to growth ratio basis.”

Green notes that Harrison’s track record of operating ratio improvement at Illinois Central and CN “led to impressive stock performance. In the case of CP, we believe the stock has further to go, as we are 18% ahead of consensus for Fiscal Year 2013 . . . and we see upside to U.S.$128 by year-end 2013. We forecast CP to realize a 72% OR in 2013, with a clear path toward a mid-60s OR by 2015.”

Greene says that Morgan Stanley “does not subscribe to the view that CP is uniquely challenged such that a mid-60s OR is improbable, a point we expect management to address at CP’s Dec. 5th Investor Day. Our work shows that closing the productivity gap with CN is likely to be a major driver to OR in Harrison’s first two years on the property.”

Morgan Stanley’s Investment Thesis on CP: “As indicated when activism began, the turnaround at CP has the potential to be the most significant investment opportunity in railroads for the next three years. The arrival of Hunter Harrison should catalyze change on a network that is certainly not broken and arguably has strong potential. While we acknowledge that key man risk and weakening macros are concerns, we see significant opportunity for OR improvement at CP with non-economic drivers to growth and productivity.” Morgan Stanley says its Best Ideas are “leading stock investment insights, the best combination of highly differentiated research, favorable risk-reward profiles, and clear catalysts.”