Canadian Pacific: Off the Tracks After Ackman [The Short Case]VW Staff
Investors in industries deemed popular or in vogue by the general public have a propensity toengage in folly often resulting in the manifestation of valuation bubbles for the pioneering companies. As the great Charles Mackay wrote in 1841:
“Men, it has been well said, think inherds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one.” Nearly two hundred years later, these words are still relevant as even nowadays men find it difficult to act against the herd while the herd goes mad.
Canadian Pacific Introduction
Like Bill Ackman’s legendary bicycle ride on the Montauk Highway last summer, the Canadian Pacific Railway Limited (the Canadian Pacific or the “Company” )(NYSE/TSX: CP) share price has recently spurted ahead of its comparables in an unsustainable fashion as it has more than doubled to $126.96/share from $60.62/share before Ackman started his activist campaign less than 18 months again. While Canadian Pacific’s recent share price performance is impressive,investors may soon be yelping in pain like Mr. Ackman when his Montauk bike-ride pace faded and debilitating leg-cramps set in.
Like its peer Canadian National Railway Company (NYSE: CNI)(TSX: CNR), Canadian Pacific is a Class 1, transcontinental mainline railway. A core tenet of the mainline rail business is funneling as much rail traffic from feeders and connectors as possible onto a high-density mainline railway network. Thus,the two main divers of railway profitability/cash-flow are carload volumes and cost controls, both of which are intended to be maximized through the economies of scale in the mainline business model. In addition, the railroading business in general has high sustaining capital intensity, as both the physical track and the rolling stock (locomotives and rail cars) require frequent maintenance and replacement to sustain efficient and safe operations.
Canadian Pacific’s potential economies -of-scale are significantly limited relative to its peers because the Company operates a significantly smaller network of only 14,400 miles of track through predominately rural areas with approximately 55% of the geographic footprint in Canada and the remainder in the United States.