On the same day that Canadians celebrate the country’s 150th birthday, a venerable national institution will get a new leader. Next July 1, Keith Creel will take over as CEO of Canadian Pacific Railway Ltd. (TSX: CP), where he’ll have to continue writing one of corporate Canada’s most enduring success stories. Creel has big shoes to fill. He replaces railroading legend Hunter Harrison, who, in three years, transformed CP from one of the worst railway businesses in North America into one of the best.
To recap: In 2012, U.S. activist investor Bill Ackman saw two Canadian railways with vastly different operations. Canadian National Railway Co. (TSX: CNR) was the gold standard, while CP was considered the opposite. That didn’t make sense to him; they traversed similar regions and carried the same products. He bought a 12% stake in CP, waged a proxy war with its board and, in what’s now heralded as a stroke of genius, brought CN’s former CEO Hunter Harrison out of retirement to whip CP into shape. “This is a great example of successful activist investment,” says Keith Schoonmaker, an analyst with Morningstar. “This wasn’t happening without him.” (Ackman’s Pershing Square Capital has had less success with another Canadian target, Valeant Pharmaceuticals International.)
Between 2012 and 2015, Harrison reduced head count, improved train efficiencies, closed redundant yards and streamlined workflows. He essentially worked the same magic at CP that he had at CN. Within those three years, Harrison reduced CP’s operating ratio—the railway business’s main profitability metric—from an industry-worst 81.3 to 64.7 (lower is better). It has fallen even further this year, to about 57 in the third quarter. That’s an incredible improvement, says Schoonmaker.
In September, Ackman sold his remaining stake in the company and quit the board. He likely felt his work was done and that it was time to take his profits, says Logan Purk, an analyst with Edward Jones. Harrison will resume his retirement in a few months. But the railway industry is struggling. Volumes are down, thanks to declining demand for coal and other commodities, making it difficult to raise prices.
Now that CP is the second most efficient North American railway—CN is still tops—it should be able to weather industry storms and transition-related hiccups. Not that there should be many, says Purk. Creel is a Harrison disciple and has worked alongside him at both CN and CP. Purk expects Creel to continue cutting costs and finding efficiencies.
Schoonmaker thinks Creel can get the operating ratio down to 55 (an “insanely low number”). But that would be a small improvement compared with recent history. By his estimate, the stock’s fair value is $193, near its current price. CP remains more attractively valued than CN, and both should see a bump if the economy improves. But as Ackman’s departure indicated, it will appeal to a different, more conservative investor henceforth. “This is an excellent company,” says Schoonmaker, “for people who are interested in buying high-quality companies that are going to be around for a while.”
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