Canadian Railroads Will Continue to Underperform Short Term - Desjardins

Canada's major railroad companies, CNI and CP, have long used the Canadian dollar and the price of oil as "shock absorbers" for negative profitability, but Desjardins warns against buying back into the weak train sector as carloads have not rebounded along with the surging loonie and crude oil.

"There have been no signs of improvement in weekly carload numbers," Desjardins transportation analyst Benoit Poirier said in a note on the railroad sector Friday.

Railroads have traditionally benefited from a weak loonie and low price of crude oil, but both have made great gains since the start of the market run up in March.

"We believe that [these run ups] will prompt further cost reductions at CN and CP, as carloads have yet to recover," he said.

Mr. Poirier does see a light at the end of the train tunnel. He predicts an 18% drop in carloads for the second quarter for CN, but for those numbers to improve to 15% and then 13% in the third and fourth quarters. CP's numbers will be comparable, he said.

Desjardins prefers CN over CP in Canada. If investors are looking at the two based on earnings power, Mr. Poirier suggests it is too soon due to a lack of any sustained traffic recovery and uncertainty over pricing power in the medium term.

He would rather investors focus on operating and financial metrics, citing strong fundamentals and potentially significant price appreciation in the long-term.

Mr. Poirier said:

Regardless, while we believe the Canadian railroads are solid companies, we do not believe they are the best short-to-medium-term investment opportunity in the industrial space at this time.