The change in the U.S. tax code is so significant that even Canadian companies such as Canadian Pacific Railway (NYSE: CP) are feeling the effects on their bottom line. This past quarter, the company logged a significant one-time gain thanks to those changes, but the more important story was that it was able to deliver exceptional operating results while overall rail traffic ticked up.
Numbers this good might make you think that there isn't a whole lot of room left to run, but Canadian Pacific's management seems to think otherwise. Here are quotes from the most recent quarterly conference call that highlight why the company thinks things will get better from here.
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Things looking up across almost all sectors
I can't think of a better economic bellwether than railroad companies. As the go-to shipping method for agricultural products, commodities, energy, autos, and, and intermodal transport, you can learn a lot about the health of various sectors based on shipping volumes. With that in mind, investors have to be feeling good about Canadian Pacific and the economy in general when CEO Keith Creel dropped this line during the conference call.
What is even more encouraging is that these results span a wide variety of products. This should give investors reasonable confidence that this economic growth phase will continue for some time.
Smashing operating records
Whenever a transportation and logistics company runs at record levels, it typically means that capacity is strained and can lead to higher incident rates or higher costs. Surprisingly, that wasn't the case this past year. According to Creel, Canadian Pacific's safety record was incredibly strong.
CFO Nadeem Velani also noted that the company's operating statistics were equally robust.
According to Velani, fuel costs for the fourth quarter were up 19% compared to this time last year. So, to post a lower operating ratio -- the railroad industry's lingo for operating income margin, which is operating expenses divided by revenue -- while shelling out that much more for fuel is quite a feat.
Don't fret fewer share repurchases
Railroads aren't what you would call a high growth industry. Delivering mid- to high-single digit earnings growth is considered a great year. What makes these companies great investments is their ability to deploy free cash flow for dividends and share repurchases. That earnings growth rate, coupled with a share repurchase program, can quickly translate into double-digit earnings-per-share growth.
During the conference call, Velani mentioned that Canadian Pacific's share repurchases for the upcoming year may be a little lighter than normal. That sounds a bit strange after announcing good results and an improving outlook for 2018. He explained, though, that investors shouldn't be overly concerned because this is a short-term matter.
One of management's other stated goals is to reduce Canadian Pacific's debt leverage -- measured by adjusted net debt to adjusted EBITDA -- into the 2.0 to 2.5 times range. At the end of the quarter, the company's leverage was 2.6 times. The retirement of some debt now should therefore put it in the desired range and reduce interest expenses, which should translate to more free cash flow in the future.
Capitalizing on a competitor's weakness
A rival's crisis is a terrible thing to waste. This past quarter, Canadian Pacific's largest competitor, Canadian National Railway (NYSE: CNI), had some capacity issues for its Canadian grain shipments and its CEO stepped down. Needless to say, Wall Street hasn't been entirely happy with the situation. So, of course, Canadian Pacific is using this as an opportune time to invest in its grain capacity. Here's Velani with the capital spending outlook for 2018.
What a Fool believes
Canadian Pacific put together another good quarterly performance where it was able to deliver better operational performance without sacrificing too much for capacity and safety. That is critical because cutting costs to the bone can expose a railroad company to significant disruptions if there isn't sufficient spare capacity to cover for a minor incident -- see Canadian National. Investors should also be excited to see management take advantage of a competitor's weaknesses to potentially grow its agriculture segment, even if it means that it will back down from its share repurchase program for a while.
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