By Matt Doiron
Hedge funds and many other large investors filed their 13F documents earlier in August, disclosing many of their long positions to the public. We have gone through these filings and detailed several of the top positions that various billionaires have in their or in their funds' portfolios. We have also noticed that three of the top six positions in the railroad industry held by billionaires. According to our database, Canadian railroads Canadian National Railway (NYSE:CNI) and Canadian Pacific Railway (NYSE:CP) saw significant hedge fund interest thanks to a big increase in D.E. Shaw's position at the first and a new position at Louis Bacon's Moore Global Investments in the second (see more stock picks from D.E. Shaw and Moore Global). These two funds joined Bill Ackman's Pershing Square, whose 24 million share position in Canadian Pacific was unchanged from the previous quarter, in investing in the United States' neighbor to the north (find more of Bill Ackman's investments). Is this because these railroads happen to be particularly large? No, Union Pacific (NYSE:UNP) is easily the largest publicly traded North American railroad by market capitalization, and CSX (NYSE:CSX) and Norfolk Southern (NYSE:NSC) are larger than Canadian Pacific as well.
Bacon and his team seem to be investing in Ackman's attempt to turn around Canadian Pacific. At the moment the company is not at a particularly good value; it trades at 22 times trailing earnings, and saw its net income fall last quarter compared to the same period a year ago. Wall Street analysts expect a rebound, and therefore the stock trades at only 15 times their expectations for 2013. This past May Ackman took over the company's board, and the fact that the company's decreased earnings last quarter still beat expectations has helped drive it up 22% this year.
D.E. Shaw's pick, Canadian National, looks very interesting to us on its investment merits. Despite double-digit percentage increases in revenue and earnings in its most recent quarter compared to last year, analyst estimates have a forward price-to-earnings ratio of 15, unchanged from the trailing P/E. In other words, it is a value stock that has been seeing good growth recently.
In addition, both of these companies are tied to the Canadian economy. Canada's economy has been doing well recently, partly because of a better housing market- though some say this market is beginning to show signs of a bubble- and partly because of the country's large oil reserves and other natural resources in an economic environment that could put upward pressure on commodity prices in the long term. The Canadian dollar is up 4% this year against U.S. currency, despite the U.S. dollar's own rise as it serves as a safe haven from economic weakness in Europe.
The U.S. railroads, however, offer investors good value and an economy that at least so far is managing a recovery. Union Pacific trades at 16 times trailing earnings, and the P/E for both CSX and Norfolk Southern is 13. The latter two companies reported essentially flat revenue and earnings last quarter compared to the same period in 2011, but Union Pacific shows strong growth, justifying its higher multiple. On a forward basis Union Pacific trades at 13, and the two smaller companies at 11, times analyst earnings estimates. Their five-year PEG ratios are 1 or slightly below that figure, while the Canadian railways are well above it.
It's tempting to get behind Bill Ackman and invest in Canadian Pacific as Bacon did, but compared to the domestic railroads and even to its Canadian competitor it looks overpriced and not nearly as safe an investment. Ackman has certainly been successful recently, but past performance does not guarantee future returns. We'd pick Canadian National over its smaller peer, and would probably choose Union Pacific over either as it seems to be growing nicely and carries more appealing valuation multiples.