Amid a North-American-wide slump in traffic volume, falling prices for railroad-transported commodities like coal and oil, and an economy that appears to be increasingly unstable, Canadian Pacific, the second publicly traded Class I to report fourth-quarter and full-year 2015 financials, fell short of analyst expectations, based largely on a nosedive in net income, despite reporting record earnings per share and an improved operating ratio.
CP on Jan. 21, 2016 announced fourth-quarter 2015 diluted earnings per share of C$2.08 and adjusted diluted earnings per share of $2.72, the highest-ever for the period. For the full year, reported diluted EPS was C$8.40 while adjusted diluted EPS climbed to a record C$10.10, a 19% improvement over 2014’s adjusted EPS of C$8.50. CP said its “commitment to operational efficiency” produced a fourth-quarter adjusted and reported operating ratio of 59.8%, “matching the record-setting performance of a year ago.” For 2015, CP posted a best-ever full-year adjusted and reported operating ratio of 61% and 60%, beating the previous record, set in 2014, by 370 and 470 basis points, respectively. CP also reported record revenue of C$6.71 billion for full-year 2015, as well as record free cash flow of C$1.16 billion, an increase of 59%.
That’s the good news CP included in its earnings press release. CP’s fourth-quarter 2015 numbers in reality fell short of analyst expectations. Net income slipped 29% to C$319 million in the fourth quarter. CP’s adjusted EPS of $2.72 missed the analyst consensus of $2.76. Revenue was slightly below forecast, at C$1.6 billion. For full-year 2015, though EPS rose 19% to C$10.10 on revenue of C$6.7 billion, analysts had been expecting EPS of C$10.18. As a result, CP’s share price on the New York and Toronto stock exchanges declined by about 5% after its earnings were released.
CP’s share price has not been immune to the overall decline in railroad stocks, dropping from a five-year of high of $214.67 on Oct. 3, 2014 to $101.00 (as of 1:00 pm EST) on Jan. 21. Year-to-date, CP’s share price has fallen $18%.
In its earnings press release, which did not mention the 29% drop in fourth-quarter net income, CP CEO E. Hunter Harrison remained optimistic. “Thanks to our committed, hard-working employees across the network, we have produced a record low operating ratio along with record earnings per share,” he said. “Despite challenging economic conditions and lower commodity prices, we continue to focus on what we can control—lowering costs, creating efficiencies and improving service. While the North American economy braces itself for more headwinds, we remain optimistic about the future and CP’s continued growth. Despite the challenges, we expect 2016 to bring an operating ratio below 59& while generating double-digit EPS growth—a testament to the strength of our operating model and plan for the future.”
At CP’s earnings call, Hunter Harrison was, as expected, peppered with questions about its proposed acquisition of NS.
“There are many moving parts in M&A (a merger and acquisition). It’s becoming a political process in a way that we had not anticipated; this could change our approach. At the worst, the M&A fails, but we still have a great railroad in Canada.”
When pressed for more detail, Harrison responded: “Long-term, M&A will happen, we just don’t know when,” he said. “What’s in the public interest? Why are two cultures unsafe? (Editor’s note: Was this comment a stab at FRA Administrator Sarah Feinberg?) Will the legislative branch take over? What’s best for CP shareholders? Why is a voting trust suddenly not workable for us when it's worked 144 times in the past? Our owners may be in support, but they don’t call the shots anymore.”
“Is the M&A deck stacked against you?” asked Cowen and Company Managing Director and Railway Age Wall Street Contributing Editor Jason Seidl.
Responded Harrison: “It’s now a political action. Even though we’ve made no proposal, judges are talking about the case before there’s even a case. We ought to let the STB process work as intended but we’re moving away. Politicians rail about gridlock, we offer a solution, they object. Catch 22.”
“How are CP employees taking all this?” asked Seidl.
CP employees are basically pleased with progress made thus far,” said Harrison. “We all know that as long as CP puts the focus on execution, good results will follow.”
“Why do you think you can do merger if the politicians are against it?” asked an analyst from Morgan Stanley.
“Our choices are, do we take more criticism for insufficient infrastructure or do we do something to fix it to absorb more volume?” said Harrison. “Chicago rail traffic is set to double in 10 years. If we do nothing, the rails will stall. What will the NIMBYs who are against adding infrastructure—or making better use of using the infrastructure we have—say when they run out of stuff the railroad brings? We have a railroad to run and a common carrier obligation to fulfill.”
So where could all this be headed?
Some rail industry observers believe that activist hedge fund principal and principal CP shareholder Bill Ackman’s dogged pursuit of Norfolk Southern is motivated purely by his desire to stanch the bleeding in his portfolio.
CP’s share performance doesn’t bode well for Ackman, whose Pershing Square Holdings (the publicly traded vehicle of Pershing Square Capital Management) has fallen 14.5% so far in 2016, according Business Insider. 2015 was Pershing Square’s worst year in its history, nose-diving 20.5%.
Ackman’s five largest holdings include Valeant Pharmaceutical (–12% year-to-date), Air Products & Chemicals (–9.6% YTD), Canadian Pacific (–18% YTD), Mondelez (–9.3% YTD), and Zoetis (–8.6% YTD). Ackman is also an investor in Platform Specialty Products, which has dropped 40% YTD. Howard Hughes Corp, another of his long equity holdings, has fallen about 15%.
“Hunter could be setting up the Street for a merger pull-back announcement, based on the political push-back and the continuing drop in CP share prices,” in the opinion of Railway Age Contributing Editor Roy Blanchard. “It’s also possible that enough NS shareholders will go for the money—70% of shares are institutional ownership—allowing Ackman to pull off what he did at CP: get his own people on the board and install Hunter as President. Then, NS becomes another Pershing Square holding, and with Hunter at the controls stands a chance to offset Pershing losses elsewhere.”
Railway Age Editor-in-Chief William C. Vantuono Contributed to this story.