Jan 25, 2023
Holding Name: Canadian Pacific Railway (CP)
Percent weighting of strategy: ~5.5%
TLDR: The Kansas City Southern merger was put into question following a recent letter from the DOJ questioning the transaction. We believe this falls outside of the DOJ’s jurisdiction and they won’t be able to derail this key component of our investment thesis.
Business overview: Canadian Pacific Railway Ltd (CP) is an operator of transcontinental freight railway. It offers rail and intermodal transportation services connecting the business centers of Canada from Quebec, Montreal to British Columbia, Vancouver and the US Midwest and Northeast regions.
The company transports bulk commodities and merchandise freight while serving as the primary grain shipper for the west Canada and northern US regions. Canadian Pacific’s top 3 largest segments are grains (21%), intermodal (21%), and energy/potash (19%) with strong growth coming from the Port of Vancouver.
The company operates a diversified business model while generating revenues around the globe. Approximate revenue breakdown can be characterized below:
Global Revenue: 34%
Canada to US: 22%
US to Canada: 8%
Why we own it: Canadian Pacific is a best in class franchise with strong competitive moats, dominant market share, and stable/increasing margin profiles. Given that they operate in a duopoly with Canadian National (hint: another holding in Offshore!), Canadian Pacific has significant pricing power advantages as seen by the 3-4% pricing CAGR (annualized growth rate) over the past 15 years.
Canadian Pacific has proven to be a defensible business model with a solid track record of robust margin expansion and operational execution. CP’s diversified business operations should enable the company to deliver GDP+ growth along low double digit earnings over the next several years.
CP generates attractive returns on invested capital (they’re efficient when investing capital back into their business), strong free-cash-flow and a compelling share repurchase and dividend program. Combining this with the recent acquisition of Kansas City Southern (KSU), we believe the company will be able to accelerate growth and unlock more than $1 billion in EBITDA per year in growth opportunities.
What’s the latest: The Department of Justice sent a letter to the Surface Transportation Board (STB) on January 24th reiterating its cautious view on the proposed merger between Canadian Pacific and Kansas City Southern. The letter emphasized the importance of protecting and promoting competitions in the railroad industry.
Although something to monitor, we believe that the letter is a non-event and have been following merger proceedings diligently (a key part of our thesis). The Department of Justice conceded that the STB has jurisdiction over the matter and the STB has been accommodative of the merger following a comprehensive review of all materials. TLDR: the STB has full control over the ruling and they have been consistently positive on the deal’s closure.
Sign posts moving forward: We will be closely monitoring any news that comes from the DOJ’s recent letter to the STB as merger synergies are key to our growth thesis over the medium term.
The new labor regulation that took effect in December is important and we will be getting a read through on the additional overhead costs and its corresponding impact on margins. We’ll also be monitoring the contract book repricing for FY23 and the volume growth trends for Kansas City Southern and they added US-Mexico rail capacity in the second half of 2022.
Interesting alt data to follow includes, easing auto chip shortage trends while closely watching the recovery in Canadian grain crops.
The content contained in this material is intended for general informational purposes only and is not meant to constitute legal, tax, accounting, solicitation of an offer, or investment advice.
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