CP’s next move?

A bid for CSX does not suggest that all of CP's growth potential lies eastward.

In the wake of Canadian Pacific Railway’s offer to merge with CSX, there was much speculation about CP’s ambitions in the eastern U.S. Adding CSX to its route structure would broaden CP’s ability to move Canadian and North Dakota crude to refineries and export terminals along the Atlantic Coast. Unifying its connection with CSX at Chicago could streamline the movement of international traffic through North America’s most congested freight rail hub. And while it can only be assumed that CSX might have faced reductions in workforce and property similar to those imposed at CP under CEO and Railway Age 2015 Railroader of the Year E. Hunter Harrison, it’s almost certain that investors and even a few shippers would have been favorably impressed by his acquisition of a key U.S. carrier.

But don’t let a stalled attempt at eastward expansion distract from the other areas where CP is eyeballing growth potential. In fact, as far as the Northeast goes, around the same time CP announced its interest in CSX, CP also hinted it might soon be selling most of its former Delaware & Hudson Railway network. CP would keep possession of D&H trackage as far south as Albany, N.Y., where it serves a rail-to-vessel terminal that CP investor literature describes as “our main crude unloading destination.” All of these proposed maneuvers seem to back the opinion of one Wall Street analyst who said CP’s bid for CSX “was all about oil.”

Northwest from Chicago to the Canadian border, CP operates a nearly 1,000-mile corridor on the former Soo Line—plus hundreds of miles in related U.S. branch trackage—and it interchanges on or near the U.S./Canada border with Union Pacific (Idaho) and BNSF (Washington, Montana). Could either of America’s Western Class I’s be courted next by CP?

Not likely, if you accept at face value an excerpt forwarded to Railway Age by CP from an Oct. 21, 2014 investors conference call, in which CEO Harrison said, “I haven’t talked to any of them other than CSX about this. So I want to make that part clear. . . . I guess when you place a little reality on it and you start thinking about the likelihood, I think the likelihood in my view, I could be wrong, it’s much lower with the two Western big boys.”

That hasn’t stopped CP from growing its own business. And for CP, that business lies largely in the West. The company’s 2014 profile states, “Grain is CP’s single largest commodity, accounting for 22% of our freight revenues.” In 2013, that meant roughly 438,000 carloads of grain or grain products, producing $1.3 billion in revenue. That volume rose nearly 6% during the first half of 2014, and not just basic grains like wheat and barley. Corn, soybeans, and canola out of the Canadian and U.S. interior feed an increased demand for biofuels, food, and animal feeds both domestically and abroad.

Roughly two-thirds of the grain hauled by CP is of Canadian origin, and much of that (49%) rolls west to export terminals in the Vancouver, B.C., area. The other third of CP’s grain haul originates mainly in North Dakota or Minnesota and moves toward milling or export on the Great Lakes, East Coast, or Pacific Northwest. To reach the PNW, CP runs grain trains northward from the U.S. into Canada, then west to Kingsgate, B.C., where they re-enter the U.S. on UP trackage for final delivery to export or processing terminals in Washington and Oregon. Grain and oilseed traffic originating on CP also moves south to California.

After grain, CP’s next biggest revenue generators during 2013 and first half of 2014 were intermodal and coal. CP hauled 43% of its intermodal strictly within Canada. Another 34% of its intermodal was international container traffic that moved through Pacific ports in Vancouver, while 18% of its international containers passed through the port of Montreal.

CP hauled roughly 245,000 carloads of Canadian coal in 2013—more than 93% of which was exported through West Coast terminals—plus another 85,000 loads of U.S. coal destined for Midwest utilities and Pacific export. Andy Cummings, manager-media relations at CP, tells Railway Age, “The corresponding increase in demand for Canadian metallurgical coal will be met by announced Teck expansion plans and greenfield development in both northeast and southeast British Columbia. CP has been in discussions with a number of parties regarding mine development plans near our main line in southeastern B.C. With a reserve of high-quality coal at these locations, CP’s current and potential partners are expected to maintain a strong position in the metallurgical coal marketplace.”

As for thermal coal, Cummings says, “CP volumes in the U.S. have not been impacted to the extent seen across the marketplace, largely due to the fact that the power generation facilities we serve have less ability to switch to gas with their current infrastructure. As well, these facilities are newer and have been able to meet regulatory standards with relatively less investment. Growth in Asian demand will continue to present opportunities for incremental movements of PRB-originated coal. We participate in the most efficient route to Prince Rupert’s Ridley Terminal and are well positioned to capitalize on future opportunities to supply the market.”

CP’s grain, intermodal, and coal traffic rely on a network of feeder lines that lead toward Northwest ports, and also on a core main line that offers direct, competitive service between those ports and Chicago as well as eastern Canada. Cummings says, “CP is currently in a multi-year process of installing Centralized Traffic Control between Glenwood, Minn., and Moose Jaw, Sask., to meet the needs of our customers. This is a corridor where we see strong prospects for growth in a wide variety of commodities.”

That project will benefit CP’s cross-border business through St. Paul/Minneapolis and Chicago. CP is also improving fixed plant in Canada, where Cummings says, “We continue to invest in our ‘North Line’ between Portage la Prairie, Man., and Wetaskiwin, Alta., with the final stretch of jointed rail on that route set for replacement with welded rail in 2015. We’ve begun a five-year ballast program on the line to enable faster train speeds, while new and extended sidings are also added.”

Cummings says that these two routes represent “renewed focus” by CP, but similar investment in renewal and capacity expansion is under way across the system.

Two other product lines pointing toward Western growth for CP are crude and potash. Though representing only 6% of CP’s freight revenue in 2013, crude is its fastest-growing commodity. In 2011, CP moved 11,000 carloads of crude, earning $29 million in revenue. In 2013, it moved 90,000 crude loads for $375 million in revenue. CP expects it will reach nearly 120,000 crude loads in 2014, and expand beyond 200,000 loads in 2015. Much of that growth is anticipated for Eastern markets, where crude by rail (CBR) provides an option when capacity isn’t readily available via pipeline or Great Lakes-St. Lawrence Seaway vessels. But in the West, CBR is currently the most practical way to channel increased Canadian crude production through the Rocky Mountains and on toward the coast. CP originates crude traffic that ultimately interchanges to BNSF and UP to reach refineries or barge terminals in the Pacific Northwest and California.

Only recently have CP’s earnings from crude outpaced potash, which produced 5% of CP’s revenues in 2013. Of the 68,000 carloads of potash CP hauled toward export in 2013, 70% went straight west to Vancouver, while 30% went south into the U.S., then west via UP to Portland. Potash shipping conglomerate Canpotex recently announced it will invest $140 million to expand its Portland rail-to-ship terminal. It also received permits to build a new $775 million terminal at Prince Rupert, which would give Canadian potash producers a third outlet on the Pacific Coast. Export capacity will be key to the K+S potash mine that’s now under development near Moose Jaw, Sask. CP says it will be the exclusive rail carrier for this new site, which is expected to begin shipping by late 2016.

Along with CP’s investment in new track and capacity, there is continued reduction of what it considers to be surplus properties. A number of yards and other facilities have been closed, leaving CP with more than 45 parcels, totaling more than 4,000 acres, that it hopes to sell or lease for commercial or residential development. During the October 2014 investor conference, CP said, “Underutilized track will continue to be removed and monetized,” and noted that 100 miles of such track had been identified to date. More specifically, CP said 13 sidings totaling nearly 16 miles of track could be removed from the rugged canyon and mountain territory between Vancouver and Calgary, and some of that rail could be used to lengthen three other sidings on that route, plus a fourth siding on its route leading toward a UP connection at Eastport, Idaho.

Cummings says, “In 2011, CP’s year-to-date operating ratio at the end of the third quarter stood at 82.4%. This year [2014], it’s 66.4%.” That figure is notable. When Harrison joined CP in 2012, he said he’d attain a mid-60s ratio by 2016. Having accomplished that in half the time, he recently told Canada’s Financial Post, “We’re doing things that people didn’t think were imaginable.”

In that same Financial Post interview, Harrrison said, “Railroads aren’t different in North America. We all run on the same gauge. We’ve got the same cars.” There’s a degree of truth to that. But what continues to be ignored by many investors and the financial media—who tend to measure the performance of CP and others by final tallies of revenue-to-cost, ROI, tons-per-mile, etc.—is that CP operates across some of the most unforgiving geography in North American railroading.

CP’s chief competitor, CN, crosses the Continental Divide at an elevation of just over 3,700 feet, with ascending grades of only 0.4% westbound and 0.7% eastbound. But for CP, the summit of the Rockies lies at 5,300 feet, plus a second major hurdle at nearly 3,500 feet in the Selkirk Range.

On both of CP’s mountain passes, ascending grades are 1% westbound and 2.2% eastbound. That’s more than twice as steep as CN.

To say that CP has a tougher route than CN between the Canadian heartland and the Pacific Coast is an understatement. To expect CP to perform there in the same manner as CN and achieve the same operating ratio as CN seems unthinkable. And yet, somehow, Harrison has come remarkably close to doing just that. A large measure of his success rides precariously on the shoulders of CP’s downsized workforce, and the leaner system in which it now operates.

Where all of this leaves CP headed is anyone’s guess. CSX has proven there’s no crystal ball offering guaranteed outcomes on Hunter Harrison’s behalf. He could buy and build his way deeper into the American West, take a new approach at cracking the Northeast, or keep CP’s growth confined within Canada itself. Anywhere grain, coal, crude, and containers must go, that’s where CP will likely make its next move.