Investment In Intermodal A Prudent Move by Canada Pacific

Canada Pacific Railway's (CP) decision to increase its focus on intermodal freight is part of its wider diversification strategy to decrease its reliance on freighting commodities. We believe that the substantial growth in domestic intermodal freight, together with the projected increase in European imports in the wake of the new FTA between Canada and Europe, will stimulate container traffic growth, and rising fuel prices will make rail a cheaper, quicker option compared with road haulage. Moreover the company is well placed to capitalise on this boom due to its extensive intermodal network, and stands to benefit from higher revenues and general profitability of the intermodal segment. However, we note potential short-term risks in the form of the sluggish economy, subdued consumer spending, and declining international intermodal traffic.

Over Q413, CP's profits amounted to US$82mn (up from US$15mn in Q412), derived from revenues of US$1.6bn (up by over 7%). This made FY2013 profits US$875mn, a y-o-y increase of 81%, from revenues of US$6.1bn. The company anticipates a further 6%-7% increase in profits y-o-y over 2014. Total intermodal volumes grew by a mere 0.4% over Q4, with a 1% decline in revenues to US$335mn. FY2013 intermodal volumes were down almost 2%, to just over 1mn carloads, and revenues dropped by 3% to US$1.33bn.

CP announced that based on its Q4 financial results, it will be targeting domestic intermodal traffic as a key growth segment in the future, as the sector saw a significant uptick in revenues and traffic. This compensated for the overall suppressed growth due to falling international traffic in the wake of the loss of significant contracts to its rival Canadian National Railways. It is this substantial drop in its cross-border intermodal traffic to the US which accounts for the overall limited Q4 growth in intermodal volumes and decline in revenues generated by this segment over 2013. This slump would have been far worse if it had not been offset by the growth in domestic intermodal traffic, and we expect this divergent trend to continue, as domestic intermodal cargos show increasingly strong growth.

Declining International Traffic Drags Down Intermodal
CP Intermodal Volume & Revenue y-o-y growth (%) Q413, FY2013

Canada Pacific Railway's (CP) decision to increase its focus on intermodal freight is part of its wider diversification strategy to decrease its reliance on freighting commodities. We believe that the substantial growth in domestic intermodal freight, together with the projected increase in European imports in the wake of the new FTA between Canada and Europe, will stimulate container traffic growth, and rising fuel prices will make rail a cheaper, quicker option compared with road haulage. Moreover the company is well placed to capitalise on this boom due to its extensive intermodal network, and stands to benefit from higher revenues and general profitability of the intermodal segment. However, we note potential short-term risks in the form of the sluggish economy, subdued consumer spending, and declining international intermodal traffic.

Over Q413, CP's profits amounted to US$82mn (up from US$15mn in Q412), derived from revenues of US$1.6bn (up by over 7%). This made FY2013 profits US$875mn, a y-o-y increase of 81%, from revenues of US$6.1bn. The company anticipates a further 6%-7% increase in profits y-o-y over 2014. Total intermodal volumes grew by a mere 0.4% over Q4, with a 1% decline in revenues to US$335mn. FY2013 intermodal volumes were down almost 2%, to just over 1mn carloads, and revenues dropped by 3% to US$1.33bn.

Declining International Traffic Drags Down Intermodal
CP Intermodal Volume & Revenue y-o-y growth (%) Q413, FY2013

CP announced that based on its Q4 financial results, it will be targeting domestic intermodal traffic as a key growth segment in the future, as the sector saw a significant uptick in revenues and traffic. This compensated for the overall suppressed growth due to falling international traffic in the wake of the loss of significant contracts to its rival Canadian National Railways. It is this substantial drop in its cross-border intermodal traffic to the US which accounts for the overall limited Q4 growth in intermodal volumes and decline in revenues generated by this segment over 2013. This slump would have been far worse if it had not been offset by the growth in domestic intermodal traffic, and we expect this divergent trend to continue, as domestic intermodal cargos show increasingly strong growth.

Short-Term Impediments

We note that there are some short-term risks to this strategy. First, the full benefits of the new intermodal focus will take some time to materialise, and we agree with CP that it will be at least two years, if not longer, for the company to consolidate its presence in the Canadian intermodal rail freight market. In part, this is because we only project limited growth in the country's economy between 2014 and 2015, with a concomitantly sluggish forecast for consumer spending on retail goods. In particular, we forecast total household spending in the retail sector over 2015 to fall by 6.5% y-o-y. This will, we believe, exert a downward pressure on consumer-focused imports (with only 2.7% growth forecast for the 2013-2015 period), though we expect this decline to be short-lived.

Long-Term Gains

Despite these concerns, we feel that CP's decision is a prudent one, as it is part of the core strategy of divesting unprofitable businesses and focusing on profitable ones.

In light of CP's overexposure to commodities traffic, which present detrimental risks if a slowdown in Chinese demand occurs, the diversification into intermodal freight will offer a number of upsides to the group. Plus, we would highlight that intermodal freight generates more money than other freight cargos, with higher per-user revenues, and better overall profitability. This is also true of domestic intermodal profits when compared to those from international intermodal cargos.

CP, and its intermodal subsidiary Canada Pacific Railway Company (CPRC), have already made a number of investments into the intermodal segment. For example, their new intermodal services have reduced the transport time between Vancouver and Toronto by 24 hours (and by 48 hours to Chicago). Moreover, as the map of the intermodal network shows, their network spans the breadth of Canada, not only including a large number of intermodal terminals at key cities and transport hubs, but also offering multiple crossover points into the US.

Domestic Intermodal Traffic Driving Growth
CP's Canadian Intermodal Network

In our view, the company is therefore ideally placed to capitalise on the flow of intermodal traffic, both containerised retail goods and grain, going through both of the country's major ports, Vancouver and Montreal, with intermodal terminals at both. Further growth potential to CP's intermodal business can be found in the recently signed Free Trade Agreement between Canada and Europe. This will, we believe, have a significant impact on the volume of container freight traffic, both imports and exports. In particular, importers will benefit from reduced prices on European goods, and we believe this will, in turn, spur retail-based demand for containerised goods across Canada, as retailers are able to pass lower costs onto customers, stimulating consumer demand growth (we forecast household spending on retail goods to recover from its 2015 slump and reach US$1,097bn by 2018).

In part due to the new FTA, we project manufactured imports to rise by 1.6% in 2014, to US$340bn, and see this upward trend continuing through to 2018, when we forecast imports to have a value of US$359bn. We also forecast that Montreal container traffic will grow by 14.8% between 2013 and 2018, at around 2.6% y-o-y, to reach 1.64mn TEUs by 2018, while Vancouver container traffic will rise from 2.9mn TEUs in 2014, to 3.7mn TEUs by 2018. Meanwhile rail freight traffic will rise from 169mn tonnes in 2014 to 173.2mn tonnes by 2018. These upwards trends in container traffic will, we believe, be mirrored by future growth in CP's intermodal volumes, particularly from 2016 onwards.

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Related sectors of this article: Freight Transport, Rail
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