Canadian Pacific Railway Investors Unhappy With New Acquisition

Canadian Pacific Railway (CP) announced Wednesday that it will purchase the Dakota Minnesota & Eastern Railroad for US$1.48-billion.

CP stated the deal would be accretive in 2008 and left its 2007 earnings per share guidance of C$4.30 to C$4.45 intact, according to a note from Blackmont analyst Menno Hulshof.

Mr. Hulshof added that CP also noted that it has secured acquisition financing, suspended its share repurchase & will secure permanent financing for potential expansions that will "preserve appropriate debt & coverage ratios for our investment-grade rating."

Investors appear unhappy with CP Railway's decision, driving shares in Canada's second largest railway down more than 3% in brisk trading Wednesday morning.

Scotia Capital analyst David Newman said in a note to clients the sell off may have something to do with CP's decision to suspend the share buyback program it commenced in March of this year in order to help finance the deal. Mr. Newman said CP Rail has repurchased 3.2 million shares to date, leaving an estimated 12.8 million shares on its updated normal course issue bid [NCIB].

At current prices, the analyst estimates the remaining NCIB would have implied an approximately $900-million cash outlay over the next two quarters. With it now likely that money will be applied to the DM&E purchase price, Mr. Newman told clients CP's future earnings per share could be negatively impacted.

While the [DME] deal could be accretive to our estimated 2008 EPS by up to C5¢, the offset, of course, is the suspension of its share repurchase program, which could reduce our estimated 2008 EPS by approximately C45¢ to approximately C$4.75, in our view." he said.

Mr. Newman added the EPS downside could be reduced to approximately C25¢ depending upon CP's ability to generate free cash flow to fund the deal.

He maintained his "sector perform" rating on CP shares and left his C$80 price target unchanged.