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Derailments Of Tanker Cars Could Derail CP

Jul. 07, 2013 4:47 PM ETCP
Michael Blair profile picture
Michael Blair's Blog
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There have been a spate of derailments in Canada of tanker cars filled with crude oil as pipeline capacity has become tight and spreads between Canadian and West Texas Intermediate oil prices have become wide. The first handful involved rail cars being moved by CP Rail (CP) and resulted in quite minor spills with limited environmental impact. CP Rail reported that the cost of clean ups would be on the order of $25 million in Q1, soon to be released.

The most recent spill did not involve CP but was catastrophic for a small town in Quebec, with one person known dead, others missing, and a lot of damage to the small town from related fires.

Canada has been urging the Obama administration to approve Transcanada Corporation's Keystone pipeline to ease the bottleneck affecting Western Canadian oil shipped to the U.S. market. Environmentalists have been opposing Keystone although there is little real evidence of environmental damage from pipe as opposed to rail and the environmental impact of producing the oil - much of it from Alberta's tar sands - is in common between pipe and rail shipments.

This Quebec disaster is surely going to increase the stakes for rail carriers, and may prompt a favourable decision on Keystone.

Regardless, it is not good news for CP which has enjoyed burgeoning demand for oil by rail while coal shipments have declined.

CP is in my view overvalued in any event. With a market capitalization of $21 billion supported by only $570 odd million of earnings, CP needs dramatic growth in profits to sustain its share price. Lower shipments of oil will get in the way of that growth.

In my view, well run railroads are worth 12 to 14 times earnings. If CP were to double net income (a challenging task to be sure) it would earn about $6.50 per share and a high range valuation would be $77. Today it is $120. I am short the stock

Disclosure: I am short CP.

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