Railroads: Better Deals in Canada?

The railroad industry is sufficiently important to the US economy that it has the clout to have its own national “day” on Capitol Hill.   This year, Wednesday March 7, 2018, was “Railroad Day” on Capitol Hill.  While Railroad Day will never eclipse Mother’s Day in the national psyche, railroads are like mothers in that they can too easily be taken for granted.

Railroads in the public sector are critical means of commuter transportation in the many of the nation’s larger municipalities.  In the private sector they are a critical means of transport for heavy freight.

Because publicly traded railroads primarily provide business-to-business services, their fortunes are largely dependent on macroeconomic factors and their share prices tend to move with the larger markets.  As with many shares at this point in the market’s extended bull run, most US railroad stocks are at or near current historic highs.  These highs are reflected in the relatively high price earnings ratios shown in the table below.

Railroad Company PE Ratio Price Dividend Yield
Union Pacific 22 x $133 2.19%
CSX 26 x $56 1.56%
Norfolk Southern 20 x $141 2.04%
Canadian National 13 x $73 1.93%
Canadian Pacific 11 x $177 1.02%
Kansas City Southern 21 x $108 1.33%


Part of the reasons that US railroads in particular have benefitted from the cycle of economic prosperity is that they have played a pivotal role in America’s frack-driven oil and gas boom.  Innovations in oil drilling technology has resulted in oil and natural gas being discovered in areas without existing pipeline infrastructures, such as North Dakota.  Railroads in such areas have been utilized as ‘rolling pipelines’ to transport oil.  Further, railroads play a critical role in transporting the large quantities of the sand used in fracking.

Railroads in Canada have essentially the same business model as their counterparts in the US.  As indicated in the table above, share prices of the two large Canadian publicly traded railroads have lagged US railroads.  Part of the reason for this is that the Canadian economy is more dependent on oil prices than the US economy.

Oil prices fell precipitously from roughly $110 per barrel in June 2014 to $34 in February of 2016.  This abrupt $75 drop in oil took the Canadian dollar down more than 20% against the US dollar and drove large parts of Western Canada into a severe recession.  These powerful negative macroeconomic factors naturally took their toll on Canadian rail operators as well.

Oil prices and economic conditions have certainly improved since 2016.  However, the Canadian railroads appear to be having a few missteps in transitioning from economic downturn to growth.

Canadian National (CN), in particular, appears to have been whipsawed by sudden changes in economic conditions.  CN reduced its workforce in 2016.  These layoffs came just as both the US and Canada experienced a stronger than anticipated economic upturn in 2017.

In October of last year, CN began to aggressively hire again because it simply did not have enough crews to handle increased demand throughout its North American routes.  CN’s staffing problems were compounded by an unusually severe fall and winter in 2017 – 2018.

Naturally, these staffing issues and lack of preparation for weather hurt service and resulted in customer dissatisfaction.  In the oil patch, Haliburton and other companies were vocal regarding CN’s disappointing service in delivering fracking sand.  In agriculture, large grain farming concerns have been expressing similar disappointments.

These problems at CN came to a head on Monday, March 5 when Chief Executive Luc Jobin abruptly resigned under pressure.

Canadian Pacific (CP) has heard similar criticisms from Canadian grain farmers and various Canadian governmental entities.  Both CN and CP have taken pains to assure their customers and regulators that costly shipment delays, particularly in the agricultural sector, will be addressed.  Both companies are now in the process of adding employees and additional locomotives and equipment to handle the improved Canadian economy.

The market, however, seems to have confidence in CP’s management team.  CEO Keith Creel had been CP’s President and Chief Operating Officer since 2013, before assuming the CEO role in January 2017.  Before joining CP, had been the Chief Operating Officer at CN.

Perhaps more importantly, Creel was a protégé of Hunter Harrison, acknowledged as the most influential railroad executive in recent decades.  Mr. Harrison had successful respective tenures running Illinois Central, CN and CP and died in 2017 shortly after becoming the CEO of CSX.

An important factor to keep in mind with respect to the Canadian railroads is that North America is now much more in control of its destiny with respect to oil prices than it was even as recently as 2016.  The US is now second in oil production only to Russia.  The US and Canada, as a combined entity, now exceed Russia’s production.

The US and Canada will be exporting both oil and gas at levels never seen before.  Going forward, the rise and fall of oil prices will now be driven increasingly by North American production.  Ultimately this should result in prices being less volatile and unpredictable for North American producers.

Now might be a good time to consider Canadian railroads, while they are still recovering from an oil price hangover the likes of which they may never experience again.

About Chris Donnelly

Christopher J. Donnelly, is an experienced attorney, bond analyst and fixed income strategist, with years of experience in structured finance, distressed bonds and bond related litigation in a variety of industries and the emerging markets. He is a graduate of Rutgers University (BA), The University of Pennsylvania (JD) and New York University, (LLM in Taxation). Chris is a Managing Director of Straacom, LLC and can be contacted at cdonnelly@straacom.com. Straacom provides strategic research, analysis and communications for publication and on assignment for private clients.

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