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Andrew Willis: After a multi-year regulatory review, major Canadian and American railways became one this year. And the partnership is poised to work well for a very long time.
With a single line connecting Canada, the U.S., and Mexico, we’re seeing a major competitive edge that’s likely to last decades. According to senior equity analyst Matthew Young, the greatest advantage of the now-named Canadian Pacific Kansas City Railway (CP) is its cost advantage.
Before the recent merger, CP had some of the worst margins of its class of railways – but from 2012 to 2019 the company went about a turnaround that would see it soar to a top performer. It was a tough process that involved cutting locomotives, cars and 40% of the workforce...
By using precision scheduling, CP has focused on lean operations – which, when combined with a major price advantage that makes you 10-30% cheaper than trucks – makes for a great investment opportunity.
After catching the attention of Kansas City, however, CP stock isn’t trading at a discount these days and we think railways will feel the weight of fuel and wage cost inflation in 2023. There’s also a lot of talk about recessions these days, and railways are dependent on the health of surrounding economies. However, in terms of an economic moat, downturns are when railroads can really shine – as they have in the past, demonstrating margin and pricing resiliency in times of financial restraint.
Looking ahead, if we do enter a recession, customers will appreciate cheaper shipping options as trains remain 4-5 times more fuel efficient than trucks. Just keep an eye out for who goes electric first…
For Morningstar, I’m Andrew Willis.
Bulls Say
- CP's profitability improvement has been nothing short of impressive over the years. The rail ranked among the worst margin performers in 2012 but leapfrogged to one of the best by 2019.
- CEO Keith Creel, who worked with legendary operator Hunter Harrison, has pushed to instill precision railroading principles into CP's culture, and that disciplined operating mindset likely won't disappear anytime soon.
- Compared with trucking, shipping by rail is less expensive for long distances, is 4-5 times more fuel-efficient per ton-mile shipped, and generally has ample capacity.
Bears Say
- Despite hiring progress and better network fluidity, wage inflation and normalizing yields will constrain OR improvement in 2023.
- Terminal congestion has eased and CP won solid new business in 2022, but normalizing rates in the competing truckload sector and sluggish retail-sector restocking will likely keep a lid on intermodal volume growth in 2023.
- The STB oversees railroads’ pricing in the U.S., so there will always be underlying risk of reregulation in terms of a policy shift to a more heavy-handed approach.
Editor's Note: All images are courtesy unsplash.com and AP Images.
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