Since Bill Ackman started buying shares in September 2011, shares of Canadian Pacific Railway (CP) have outperformed other large railroad companies by a wide margin. There are three reasons why CP is not my favorite railroad stock.
Based on three different metrics, forward PE ratio, price to book value, and price to sales CP is more expensive than rivals Union Pacific (UNP), CSX (CSX), and Norfolk Southern Corporation (NSC). Simply put, I do not believe CP should trade at a premium to other railroad companies.
2. Ackman Selling
Bill Ackman recently said he will reduce his stake in CP by 7 million shares over the next 6-12 months. This comes after Ackman has more than tripled his money since his initial investment in 2011. In an activist role, Ackman replced both the board and CEO, both moves have paid off as CP has vastly improved efficiency. However, there will not be another big gain to be had in terms of operating efficiency and management going forward. Like Ackman, I believe the easy money has been made in CP.
3. Narrowing Oil Spreads
Over the past year, as shown by the chart below, the spread between Brent and WTI crude oil has narrowed dramatically. This is bad new for CP because the company has benefited from increased oil shippments. CP is one of the largest railroad based oil transport companies. Union Pacific is also heavily exposed to oil shipments but other plays such as CSX and Norfolk Southern are not major players in the oil transport business.
When spreads were wide, as was the case in 2012, it was cheaper for refineries to take delivery of inland crude via train than more expensive, coastal, crude via tanker. This dynamic has since changed. Tanker shipments are now competitively priced with rail.
Despite three years of outperofrmence, CP is not my favorite railroad stock. I am cautious on CP relative to its peers because Bill Ackman is selling, CP is more expensive than its peers, and CP is heavily exposed to oil shippments which are now vulnerable due to the change in oil spreads. Instead of CP, investors should consider buying CSX or Norfolk Southern as both companies trade at cheaper valuations and are less exposed to oil shipments.