A Tail Of Two Railroads

By Arthur Pinkasovitch | June 19, 2011 AAA

Canada's major railroad transportation companies, Canadian National Railway (NYSE:CNI) and Canadian Pacific Railway (NYSE:CP), have produced rather different year-to-date performance results. While CNI is up 15%, CP is down 7%. What is causing this divergence in these seemingly similar companies?

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Canadian National Overview
CN had a solid first quarter, as revenues increased by 9% to $2.1 billion, and its operating ratio improved by 30 basis points to 69.0%. Delivery in every business component showed improvements, with grain & fertilizer revenues and intermodal transportation showing the most significant revenue gains of 9% and 12% respectively. Other significant efficiency metrics, including revenue/car, profit per revenue ton mile and number of carloads, increased significantly in the intermodal and bulk transportation segments. Despite strong overall performance measures, fuel costs surged by 29%, dampening net income growth, which still came in at 31% above last year's levels.

Canadian Pacific Railway
Due to a record snowfall in the U.S. Midwest region and supply chain issues, CP Railway experienced flat revenue for the quarter. Transportation of key intermodal freight remained at 2010 levels, while revenues generated from grain transportation declined by 14%, before adjusting for foreign exchange movements. With a large operating ratio of 90.6%, year-over-year net income fell by 67%. Many of the industry-specific metrics, such as car miles per day, train speed, train length and gross ton miles per employee, either remained flat or declined.

The harsh winter conditions in the Midwest region took a greater toll on CP results than on other operators as in the region - Norfolk Southern (NYSE:NSC) and Union Pacific (NYSE:UNP) are in the black for the year.

Why the Difference?
Cumulative freight volumes within Canada increased by approximately 2% through the first 23 weeks of 2011, yet are still down considerably from 2007 levels. As freight volumes continue to rebound, a growing number of shippers are growing dissatisfied with Canadian railroad services. CN, however, has developed a reputation for being proactive with its complaint response procedures. Furthermore, CN has a much cleaner balance sheet with a total debt to equity ratio of 0.52, in comparison to CP's corresponding leverage ratio of 0.86. As a result, Standard & Poor's downgraded CP's debt to BBB- while maintaining a strong A- rating for CN.

CN also has superior operational figures. For example, in the first quarter, CN trains traveled at an average speed of 26.3 miles per hour, and 187 miles per day. CP trains, on the other hand, traveled at an average speed of 19.8 miles per hour and covered 137.9 miles per day. Odlum Brown Ltd. equity analyst Stephen Boland notes, "CN did a very good job working through the challenging weather, whereas for CP there was a significant impact on earnings."

Shares of CP continued to fall after CEO Ed Harris retired within his first year on the job. However, management remains optimistic about future volume recovery, largely driven by strong Asian demand for commodities.

The Bottom Line
Despite its lackluster first-quarter performance, CP continues to display relatively strong fundamentals and the potential for future growth. As both major railroads begin to allocate more resources to take advantage of energy transportation requirements, the competition between Canadian National and Canadian Pacific is likely to heighten. (So, you've finally decided to start investing. But what should you put in your portfolio? Find out here. Check out How To Pick A Stock.)

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