Why CP Rail Stock Came Off the Rails After Q1 Earnings

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Canadian Pacific Railway (TSX:CP)(NYSE:CP) stock dipped over 3% after it announced it first-quarter 2022 results yesterday. Fortunately, the stock has quickly rebounded shortly after the market open.

Canada’s second-largest railroad faced what seemed like a perfect storm of challenges during the quarter. These included extreme cold weather, a COVID-19 pandemic outbreak among staff, a two-day strike with the Teamsters Union, and lower-than-average grain shipments.

CP Rail missed the top and bottom line

Consequently, both the top line and the bottom line failed to meet analyst expectations. Revenues decreased year over year by 6% to $1.84 billion. Analysts hoped for $1.95 billion. The revenue decline was largely due to a -20% decline in grain shipments. Bulk commodity shipments make up 40% of CP’s revenue mix, so this was a major factor in the revenue decline.  

Likewise, diluted earnings per share disappointed with a 30% year-over-year decline to $0.63. The market was targeting $0.72 per share. Adjusted diluted earnings per share, which factors out one-time items related to the acquisition of Kansas City Southern Railway (KSU), was $0.67 per share.

The operating ratio (operating expenses as a percent of revenue) is a key metric to determine railway efficiency. CP’s operating ratio increased 10.9 percentage points to 70.9%. That is a significant jump from its previous industry-leading 60%.

2022: A story of two halves for CP Rail stock

Despite the weak results, Chief Operating Officer Keith Creel had an optimistic tone:

“I’m not here to make any excuses this team is not going to today. We knew that it would be challenging the first half, certainly more out in Q1. Despite those challenges, our outlook on the year remains largely unchanged.”

Keith Creel, CEO of CP Rail

He further iterated that 2022 will be a story of two halves, in which the back half of the year should be significantly better. He still expects revenue tonne miles (RTM) to still grow by double digits this year.

A KSU acquisition update

Mr. Creel also brought up the process of acquiring KSU. The companies are already working to integrate some interline services. So far, the connections have been very successful.

However, the Surface Transportation Board, who are regulating the transaction, put its procedural schedule on hold while CP clarified some data inconsistencies. Mr. Creel remains optimistic that the process will resume quickly, and a final transaction ruling will be made by early 2023.

The Foolish takeaway

It was a challenging quarter, and not the one shareholders hoped to see. Yet CP could still see a decent year of growth. Certainly, inflationary factors (like rising fuel and wages) will continue to impact margins. However, this may be offset by a higher-than-usual volume of bulk Canadian exports to Europe (due to the Russia-Ukraine war).

This Canadian blue-chip stock does have a great long-term history of delivering for shareholders. It is one of the best-managed railroads in North America. However, at 23 times earnings, CP Rail stock is certainly not cheap. Its historical average is closer to 18.9 times.

Yet, if the KSU takeover is successful, its many growth opportunities may justify the premium. This isn’t a certain outcome, but I’d be willing to stomach the current underperformance with that long-term goal in mind.

The post Why CP Rail Stock Came Off the Rails After Q1 Earnings appeared first on The Motley Fool Canada.

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Fool contributor Robin Brown has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.

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