Warren Buffett's investment in America's oldest and possibly least glamorous industry, railways, left many investors searching for other interesting offerings. Canadian Pacific (NYSE:CP) reported a healthy 34% increase in third-quarter profits, yet investors sold off CP shares by more than 3% following the announcement. It appears not all investors are as excited about life on the rails.
So, why the lack of bullish sentiment? Lets dig into CP's recent follies.
Rising Costs And A Potential Write-down Looming
There were a number of things that might have turned off Canadian Pacific (CP) investors. First, management's profit outlook for 2008 was revised lower. The comapny now expects earnings per share at the low end of the $4.51-4.67 range for next year. Rising fuel costs and the impact of a rising Canadian dollar on other operating expenses are expected to squeeze margins going forward, despite expectations of continuing strong traffic volume growth.
Next, there was a disclosure of a $22 million write-down in connection with $151 million in non-bank asset-backed commercial paper that failed to mature during the third quarter as scheduled. With roughly 153 million shares outstanding, if the whole amount were to be written off that would knock as much as a dollar per share off future earnings. (If you can't tell a write-down from a write-off, check out Understanding The Income Statement.)
Recent Acquisition Will Put A Strain On CP's Balance Sheet
Last September, in a move that appeared to echo Buffett's interest in BNI, CP agreed to buy Dakota, Minnesota & Eastern Railroad (DM&E) for about $1.5 billion. The move will give it access to the coal-rich Powder River Basin in Wyoming. BNI is also a major coal-transporter in the Powder River area.
Unfortunately for CP, the deal got a failing grade from rating agency Moody's. In a published opinion following the acquisition, Moody's expressed the view that CP was paying a premium for DM&E at a time when the transportation market had already passed its peak. Moody's also warned that CP's unsecured debt could be downgraded as the company's overall debt level is expected to rise to about $6 billion.
The deal has also run into regulatory headwinds. Canadian Pacific had expected its expansion plans would be oposed by riaval BNI - and they were. What it didn't expect was that the world famous Mayo Clinic would also put up a fuss. The Mayo is seriously concerned about how the higher rail traffic levels will impact its facilities, which are near DM&E' rail line in Rochester, Minnesota. If the clinic succeeds in prompting a safety and environmental review, it would seriously undercut CP's rationale for making the acquisition.
The Bottom Line
Warren Buffett might be making the right long-term call on railways at this juncture, but not every investor has the luxury of such a broad investment time horizon. For most of us mere mortals, one year is about as far ahead as we care to contemplate. With nothing but bad news on the radar screen for CP heading into 2008, short-term focused investors have plenty of reasons to push the share price lower.
For a look at Warren Buffett's investing style, check out Warren Buffett: How He Does It.
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