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CP chief executive Hunter Harrison has moved quickly to cut jobs, close yards and speed up trains. (Ryan Remiorz/THE CANADIAN PRESS)
CP chief executive Hunter Harrison has moved quickly to cut jobs, close yards and speed up trains. (Ryan Remiorz/THE CANADIAN PRESS)

STOCK TO WATCH

Stock to watch: Be wary of CP’s surging shares Add to ...

Canadian Pacific Railway Ltd.

Last close: $122.60 a share

52-week trading range: $71.61 to $132.93 a share

Annual dividend: $1.40 a share for yield of 1 per cent.

Analysts’ ratings: There were seven buys, 18 holds and five sells, according to Bloomberg. Target prices ranged from $100 a share as estimated by Cormark Securities analyst David Newman to $149.98 a share by JPMorgan analyst Thomas Wadewitz.

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Recent history: Shares of Canadian Pacific Railway Ltd. have been on a tear since last July after U.S. activist investor Bill Ackman of Pershing Square Capital Management won a bitter proxy fight to oust former chief executive officer Fred Green. CP stock, which had struggled in recent years, has gained nearly 64 per cent (including dividends) over the past 12 months.

The runup is a vote of confidence in former Canadian National Railway Co. CEO Hunter Harrison, who was coaxed out of retirement to rid CP of its reputation as North America’s least efficient railway. His goal is to reduce CP’s operating ratio – an industry measure of efficiency that compares operating expenses to revenue – to 65 per cent in four years. In 2011, CP’s operating ratio was 81.3 per cent versus 63.5 per cent for CN.

Mr. Harrison has moved quickly to cut jobs, close yards and speed up trains. Investors will get a better look at his progress when CP releases first-quarter results before the markets open next Wednesday. The consensus earnings estimate is for $1.21 a share, or a 48-per-cent increase from a year ago.

Manager insight: Investors who missed the early ride on CP stock might want to wait for a pullback before jumping on board because “it’s still priced for perfection,” says Jim Huang, president of T.I.P. Wealth Manager Inc., who admits he sold his shares “too early” when they hit $105 in January.

As a seller, Mr. Huang has lots of company among fellow Canadian investors. A recent Morgan Stanley research report noted that the top 10 buyers of the stock in the most recent filings are Americans, while the top 10 sellers are from Canada. “Of the top 10 shareholders, only two are Canadian,” he said. “U.S. analysts are more bullish on the name. They love Hunter Harrison who is an American and once ran Illinois Central Railroad.”

CP should meet or beat expectations in the first quarter, he said. “CP has been somewhat fortunate in that it did not face significant challenges from the winter [as CN did]. There is a bit of luck involved but clearly Hunter Harrison has done what he has said he was going to do … in terms of shaking up the culture of CP so they are clearly on the right track.”

Mr. Harrison “may be slightly ahead of schedule so that is why the stock has gone so far,” said Mr. Huang. “Right now, you are pricing in the next three years of improvements. … It is currently the most expensive railway in North America on a price-to-earnings-multiple basis.”

CP trades at nearly 20 times this year’s consensus earnings versus 16 for CN, and about 16 times forecast 2014 earnings versus 14 times for CN, he said. “The average multiples for U.S. railways are even lower. There is no question that CP is expensive shorter term.”

Shares of CP shares hit a 52-week high of nearly $133 a share earlier this month, suggesting that buyers are counting on steady improvement in the company’s bottom line from now until at least 2016, he said. “You could get to almost $10 a share in earnings [by then], and if you choose a price-to-earnings multiple of 15, you could get a $150 stock by that time. But we are talking about three or four years out, and things can change.”

Even a well-managed railway can have a bad quarter because of unexpected events, such as bad weather, a slow economy, a strike or even a crude oil spill, Mr. Huang said. The rail business has benefited from the recent trend to ship crude oil by train, but a CP train had a spill in Northern Ontario earlier this month. The damage was quickly contained, he said. “Next time they might not be so lucky.”

It is reasonable to ask for a “margin of safety – as Warren Buffett calls it – and right now the stock is not giving me that,” he said. “If there is a pullback and you can get it between $100 to $110, then it gets interesting.”

Stock to Watch is a regular series on our Inside the Market blog that profiles companies that could make for profitable investing plays.

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