It's completely understandable that activist investor Bill Ackman might want to toss overboard some of his Canadian Pacific Railway Ltd. shares.
The stock has nearly tripled since the New York hedge fund manager began accumulating it in 2011. It now makes up a quarter of his portfolio, a concentrated bet on a single company that would make most money managers lose sleep at night.
But Mr. Ackman's announcement that he would sell up to seven million of his CP shares, or about 29 per cent of his holding, has raised concerns that Canada's two railway stocks are getting overvalued.
Both Canadian Pacific and archrival Canadian National Railway Co. have had terrific runs of late. CP has powered higher on the back of aggressive cost cutting and an unexpected windfall from the new popularity of moving crude oil by rail. CN has been no slouch either when it comes to capital appreciation. The railway is considered North America's most efficient and its stock has rallied accordingly, up more than 60 per cent from the lows of two years ago.
Here's the issue: Both railways have surged so much they trade at higher multiples of their earnings and book value than similarly sized rivals in the United States.
Some analysts believe the Canadian companies are no longer screaming buys. They view the two companies as "holds," a kind way of saying the analysts have a lukewarm opinion of the stocks' potential for further gains.
In the case of CN, 26 analysts rate the stock a "hold," four rate it as a "buy" and one considers it a "sell," according to Bloomberg. CP isn't as lopsided but shows the same trend: 17 "holds," nine "buys" and five "sells."
At Desjardins Securities Inc., analyst Benoit Poirier rates both companies in the "hold" category and recently told clients that "we believe both stocks are fairly valued," although he has a preference for CN over CP.
On CP, Mr. Poirier said he believes investors have already chased the stock so high that much of the hope for profit increases through cost cutting is already reflected in the share price. For CN, he sees limited upside beyond his $102-a-share target price.
In a note to clients on the Ackman sale, Mr. Poirier said it isn't too surprising that the New York investor would want to part with some of his holdings, given the level of the shares. "We thus see the news as an indication that major upside potential may be limited at current levels," Mr. Poirier said.
Comparing CP and CN to the big U.S. railways also suggests the Canadian companies are on the expensive side.
Competitors CSX Corp., Norfolk Southern Corp. and Union Pacific Corp. all trade at lower multiples of book value and earnings than their Canadian rivals. Some of the discount reflects U.S. railways' heavy dependence on shipping coal, a commodity whose use is slumping because of reduced demand from electricity generators, but that factor appears to be more than accounted for in prices.
CN and CP trade at more than four times book value, compared with the comparable figures for CSX and Norfolk of 2.8 times and 2.4 times respectively.
One U.S. railway is more expensively priced: Kansas City Southern. It has been bid up by investors to even loftier levels than the two Canadian lines because it serves the fast-growing Mexican market and is frequently touted as a takeover candidate.
Not all analysts believe the upside in the Canadian names is exhausted. Last month, analysts at JPMorgan looked at CP, and estimated it might earn as much as $12.50 (U.S.) a share in 2016 and could trade at a multiple of 16 times its annual earnings.
These metrics "imply that CP could be a $200 stock. While this is obviously a pretty optimistic scenario, it also does not appear to be an unreasonable outcome in our view," the bank said.