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Railway shares slide after earnings warning

The government moved quickly to end a strike by 4,800 CP Rail engineers and conductors last May by passing back-to-work legislation.

Nathan Denette/The Canadian Press

A surprise profit warning from Norfolk Southern Corp. sent shares tumbling across the entire North American railway industry, hammering Canadian carriers along with their U.S. counterparts.

Analysts say Canadian National Railway Co. and Canadian Pacific Railway Ltd. experienced collateral damage from Norfolk's surprise announcement that it expected earnings of $1.18 (U.S.) to $1.25 a share in the third quarter. The projection, made after the market closed Wednesday, fell far short of the $1.63 a share that analysts surveyed by Bloomberg had expected, and stunned investors.

Norfolk, the second largest eastern U.S. railway, skidded 9 per cent in heavy trading Thursday, leading declines among U.S. carriers. CN sagged 4.5 per cent, while CP dropped 2.6 per cent. Both companies had been trading near 52-week highs before the tumble.

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Transportation analyst David Tyerman at Canaccord Genuity Corp. called the decline of the Canadian companies a "knee-jerk reaction" that may have been overdone because both CP and CN are better positioned than U.S. carriers to withstand recent difficulties.

Norfolk said its revenues were hit by a decline in loadings of coal to U.S. power plants, along with reduced merchandise shipments, which rattled investors because it is a clear sign of weakness in the U.S. economy.

Revenue from a fuel surcharge used to recoup higher diesel prices, a pricing arrangement that is common across the industry, was expected to fall sharply below the year-earlier period, another factor hurting Norfolk's results.

While both CP and CN are affected by trends in the U.S., they are far less exposed than U.S.-based carriers to the recent drop in coal usage. Coal shipments have plunged as utilities shutter aging, high polluting coal-fired generating stations and replace them with cheaper natural gas.

Coal accounted for about 11 per cent of revenue at CP and 8 per cent at CN last year, according to figures compiled by RBC Dominion Securities. That is far lower than the 31 per cent level at Norfolk and the 20 per cent figure common elsewhere in the U.S. industry.

"The coal situation is different in Canada," Mr. Tyerman said. For CP, the fossil fuel is actually a bright spot because the railway is shipping more coal to Asia from the West Coast, a boost to revenues.

Canadian carriers have also been helped by the increasing practice of shipping crude oil by rail as a way around constrained pipeline capacity. In addition, CP has benefited from the recent improvement in the U.S. housing industry, which has created higher demand for lumber.

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Consequently, both CP and CN "have been able to put up decent volume numbers in the quarter," Mr. Tyerman said.

The two Canadian companies have other factors in their favour.

CN's operating margins are excellent and the company has been able to use its free cash flow to buy back shares, a shareholder-friendly move.

Speaking at an industry conference on Thursday, CFO Luc Jobin said the third quarter "has been pretty good" for CN and results "continue to track with where we've been guiding the Street."

At CP, Hunter Harrison, the company's new CEO, is spearheading efforts to improve its operating margins, which should boost profitability.

But the positives for both carriers are well known and are likely already reflected in their share prices, the reason Mr. Tyerman rates the two railways as "holds" rather than giving them a "buy" rating.

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