Canadian Pacific earnings may hit a roadblock
The government may have ordered Canadian Pacific’s union employees back to word, but now it’s up to activist hedge fund manager Bill Ackman to see if he can get them to generate better profits for shareholders.
Back in May, activist hedge fund manager William Ackman, triumphed in a bitter battle for control over Canadian Pacific Railway Ltd. (CP.N). Ackman’s Pershing Square Capital Management is the largest single shareholder in the venerable railway company, with 14% of its stock, and he has succeeded in winning a mandate from his fellow shareholders to overhaul its board and the company’s strategic direction. A board shakeup has indeed taken place, with those resigning including CEO Fred Green and the company’s chairman, John Cleghorn. But so far, Ackman hasn’t managed to do much to improve the outlook for the company’s earnings, which are on track to disappoint investors when it reports second-quarter results.
Canadian Pacific, which operates mainline rail service across Canada, from Vancouver on the Pacific coast all the way to the Atlantic provinces, with branches stretching into the US Midwest and Northeast, had been struggling and failing to generate positive free cash flow even before its unionized workers went on strike in late May and shut down its operations. (The Canadian government stepped in to order the Teamsters back to work, fearing the impact the shutdown would have on the Canadian economy.)
Not surprisingly, analysts are turning bearish on Canadian Pacific; in the last 30 days, the I/B/E/S consensus has been cut by 16%. Today, the mean estimate by analysts calls for the company to report second-quarter earnings of 92 cents a share; the StarMine SmartEstimate, however indicates that the real figure is more likely to be closer to 84 cents a share. Supporting that is the fact that two highly rated analysts have issued Bold Estimates in recent days, with earnings forecasts that are far below the mean. While bulls on the stock predict earnings could be as high as $1.12 a share, the bears see a figure closer to 60 cents.
The charts below show the reasons for this bearishness. Canadian Pacific’s cash flow has been negative for the last four quarters; in the first chart below, the red signals the extent to which it has lagged net income. In the first quarter of 2012, for instance, Canadian Pacific posted net income of $142 million – but its free cash flow was negative once more, at -$32 million. As the second chart below indicates, the company’s capital spending levels has exceeded cash flow from operations in the last four quarters, as the company spent more than $1.2 billion in that period on maintenance and new equipment. When a company forks over $233 million for capital projects during a quarter in which it generates cash flow from operations of only $201 million, as happened in the first quarter, that indicates a level of capital spending that is unsustainable.
Canadian Pacific is scheduled to announce its second-quarter results on July 25, and it should get some help from the fact that earnings and revenues in the first half of 2011 were affected by heavy flooding, giving the company an easy comparison. But Ackman’s newly appointed directors face some obvious challenges in cutting capital spending, boosting cash flow and improving operational efficiencies at the company.
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