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Railway on track for rally
Published: July 30, 2008
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Analysts say CN, and to a lesser extent CPR, positioned to gain ground on U.S. rivals.

If the battle between Canada's two largest freight carriers were a reality TV show, Canadian National Railway Co. would be out-manoeuvring Canadian Pacific Railway Ltd. for votes from Bay Street judges.

Analysts say that expansion prospects look brighter at Montreal-based CN, which is counting on the U.S. Surface Transportation Board to approve its $300-million (U.S.) purchase of Elgin Joliet & Eastern Railway Co.

CN wants to use EJ&E's strategically important tracks in suburban Chicago and avoid the train gridlock of the city's core. With its own tracks at the Port of Prince Rupert in British Columbia, CN is positioned to gradually increase the volume of imported consumer goods from Asia that head to its Memphis terminal, as well as boost exports of commodities at the B.C. port.

RBC Dominion Securities Inc. analyst Walter Spracklin rates CN an "outperform," setting a 52-week price target of $60, or 10.6-per-cent higher than yesterday's close of $54.26 (Canadian) on the Toronto Stock Exchange.

Mr. Spracklin views Calgary-based CPR as having an uphill climb, giving it a "sector perform" rating, and cutting its 52-week target price to $68 from $73. The new target is a 5.2-per-cent gain from CPR's close yesterday of $64.65.

CN's second-quarter profit of $459-million slightly exceeded analysts' estimates. But CPR's $155-million profit in the second quarter fell short of expectations, as the railway suffered from a weakening economy, flooding in the U.S. Midwest and a fuel surcharge system that hasn't been recovering as much of diesel costs as other freight carriers have been able to collect from shippers, industry analysts say.

Since mid-July, CN has been on a roll, with its stock price jumping 19 per cent, compared with CPR's increase of 6 per cent. Analysts say that both companies are positioned to gain ground on the four major U.S. railways, which enjoy higher valuations, based on price-to-earnings ratios.

CN's P/E ratio is 13.6 times next year's earnings per share and CPR's is 13.3 times, compared with an average of 15.1 times for the four largest U.S. railways, Mr. Spracklin noted.

CN has greater exposure to forest products and the United States than CPR, so when lumber shipments pick up and the American economy rebounds, CN will reap the benefits, Mr. Spracklin said. "There's excitement surrounding the Port of Prince Rupert, which is serviced only by CN," he said in an interview.

A snag is the Surface Transportation Board's announcement last Friday that it will take until early 2009 to rule on the EJ&E transaction, longer than what CN had forecast.

Still, CN chief executive officer Hunter Harrison said yesterday that he sees a light at the end of the regulatory tunnel. "We are confident that appropriate mitigation solutions can be developed that would allow this transaction to move forward," Mr. Harrison said in a statement.

CN's plans to buy Chicago-area tracks are a safer bet to become reality than CPR's long-term strategy to expand into Wyoming coal, analysts say. CPR expects to win regulatory approval by Sept. 30 for its $1.5-billion (U.S.) acquisition of Dakota Minnesota & Eastern Railroad Corp.

If approved, CPR and its partners could invest up to $6-billion for expansion into the Powder River coal basin in Wyoming. Compared with the capital outlay by CN to reduce bottlenecks in the Chicago region, CPR and others would be making a massive coal gamble - amounting to nearly 60 per cent of the railway's total stock market value, analysts say.

While an efficiency drive this fall at CPR should help cut costs, CN is seen as the less-risky bet for now. National Bank Financial Inc. analyst David Newman rates CN an "outperform," with a 52-week target price of $57 (Canadian). Mr. Newman kept CPR as a "sector perform," but lowered its 52-week target to $67 from $73.

Of course, judges don't always see eye-to-eye. For instance, UBS Securities Canada Inc. analyst Fadi Chamoun places both CN and CPR in his "buy" category, maintaining a 52-week target price of $61 for CN and $80 for CPR.

Tale of the tape

Canadian National Railway: (CNR-TSX)
Yesterday's close
$54.26, up $1.23

Canadian Pacific Railway: (CP-TSX)
Yesterday's close
$64.65, up $1.15



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