Analyst Cuts CN, CP Rail Targets Due to Weaker U.S. Economy

Canadian railways are particularly vulnerable to the current state of the economy. Slower housing starts and a weaker U.S. economy are already shrinking volumes, and the domestic manufacturing and forestry sectors are expected to be hit even harder by the strong Canadian dollar.

Because of this, UBS analyst Fadi Chamoun is reducing his earnings estimate for both Canadian National Railway Co. (CNI) and Canadian Pacific Railway Ltd. (CP).

Mr. Chamoun reduced his earnings per share estimate for CN to C$3.50 from C$3.67 for 2007. For CP, he reduced his forecast to C$4.36 from C$4.39. His 2008 and 2009 estimates were also reduced.

“While we are not projecting a recession, we are prudently moderating our expectations to reflect a more pronounced softening of the North American economy and the negative impact of a stronger Canadian dollar,” he said in a note to clients.

However, UBS expects the U.S. Federal Reserve to further cut interest rates in the United States by another 50 basis points to 4.25% by the end of the year, which will allow for a “soft landing” from the current turmoil in the markets and reduce the impact on the rails, Mr. Chamoun said. “We project a recovery in the back half of 2008.”

Mr. Chamoun’s 12-month target price for CN was also reduced to C$71 from C$73, and for CP to C$83 from C$85.

“CN Rail’s earnings are cut more dramatically than that of CP Rail due to the nature of the former’s franchise which is more exposed to the foreign exchange translation effect and the forest products segment,” he said.

CNI vs. CP 1-yr chart: