CP Rail and Union Pacific heading in opposite directions

CP Rail and Union Pacific heading in opposite directions
Union Pacific Corp. was slapped with a downgrade as a result of falling pricing trends, but railroad peer Canadian Pacific Railway Ltd. received a vote of confidence.

RBC Capital Markets analyst Walter Spracklin lowered his recommendation on UNP to sector perform, and cut his price target to US$98 from US$107, citing managements commentary on pricing trends Thursday.

Now trending below inflation, pricing is just one concern Spracklin highlighted in a note to clients.

UNPs third quarter results came in below expectations, and its operating ratio has deteriorated.

Following a period of meaningful multiple expansion this year, we see valuations at risk for UNP follow key concerns in several areas, the analyst said.

The key here is that these appear to be company specific in many cases, as we have seen other peers exhibit both solid improvement in O/R and core pricing above inflation, he added.

Core pricing at UNP has declined steadily from 4 per cent in early 2015, to 1.5 per cent in Q3 compared to the going-forward inflation run-rate of 2 to 2.5 per cent.

Pricing is and remains a key tenet to our thesis and while management is optimistic for a reversal, we are nevertheless concerned that it has dropped to this level and we now view pricing as a risk, Spracklin said.

J.P. Morgan analyst Brian Ossenbeck said UNP disrupted a key tenet for all rail investors by stating that 2017 core pricing may not exceed inflation, owing in part to rising competition.

We highlighted decelerating Q3 pricing would increase the importance of maintaining the standard core price spread over inflation in our CSX earnings recap, but even our cautious stance into Q3 earnings did not envision such an event happening, Ossenbeck told clients, cutting his price target on UNP to US$86 from US$96.

Meanwhile, CP Rail is benefiting from an increase in bulk-orientated traffic, something Steve Hansen at Raymond James expects will continue for the remainder of 2016 and in 2017.

The analyst reiterated his outperform rating and $230 price target on CP Rail shares, despite the companys Q3 earnings coming in slightly below analysts forecasts.

CP Rails operating ratio improved by 220 basis points year-over-year to 57.7 per cent, while management sees further efficiency opportunities and guided toward the low 50 per cent range in Q4.

Despite these improvements, the company trimmed its 2016 guidance to mid-single-digit EPS growth (compared to double-digit previously), as a result of the delayed Canadian harvest, weak crude oil traffic, and the weak domestic economy.

Hansen wasnt surprised by the more muted outlook, but also highlighted managements suggesting that volumes should return to growth in Q1 2017.

The analyst said this long-awaited transition is likely to carry healthy incremental margin and operating leverage.
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