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Strong economic fundamentals should translate into better volumes for both Canadian National Railway Co. (CNR-T,CNI-N) and Canadian Pacific Railway Ltd. (CP-T, CP-N) going forward, said Desjardins Securities analyst Benoit Poirier.

“Since late 2016, the various economic indicators we monitor have pointed to a substantial recovery in market conditions,” said Mr. Poirier in a research note previewing first-quarter financial results. “The U.S. inventory-to-sales ratio (lagging indicator) has improved steadily, supporting the stronger volumes seen since 2H16. In addition, inventories are slightly higher compared with historical averages (1.35 times currently versus the average since 1995 of 1.33 times), providing room for further improvement in light of better sentiment on U.S. industrial production in 2017 and 2018. That said, we expect overcapacity in the truckload industry to continue to affect pricing in 2Q for trucks and railroads. Nevertheless, the situation is expected to improve by late 2017 with the introduction of ELD (electronic logging devices) regulation, which should drive pricing power for both industries. Overall, we believe current valuations in the railroad sector already reflect these improving fundamentals. The main risks to our investment thesis are (1) political uncertainty in the U.S. related to trade, (2) a stronger U.S. dollar, which would affect the US manufacturing sector, and (3) a decline in the global economic outlook.

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