Founded in 1881, Canadian Pacific Railway (TSE: CP) (CP) provides rail services in Canada and the United States. It offers rail and intermodal transportation services and also transports bulk commodities, merchandise freight, and intermodal traffic.
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Canadian Pacific enjoys a competitive advantage due to the industry’s high barriers to entry. In addition, analysts currently have a favorable view of the company.
The Railway Industry Enjoys High Barriers to Entry
Railways are very important infrastructures that are relied upon to deliver critical supplies across North America. With new and exciting technologies occupying the minds of many entrepreneurs, this classic technology doesn’t get much attention.
This is a good thing for the railway industry because it reduces the chances of disruption. However, even if someone did want to disrupt the railway industry, it would be very difficult – and even more expensive.
Indeed, in order to simply replicate the vast network of train tracks in North America would cost tens of billions of dollars. It’s for this reason that CP is willing to acquire Kansas City Southern for $30 billion as opposed to building new tracks of its own.
As a result, the industry has a very high barrier to entry, which has allowed CP to enjoy a duopoly in Canada.
Canadian Pacific Doesn’t Have an Attractive Dividend
For investors that like dividends, Canadian Pacific currently has a 0.8% dividend yield, which is below the sector average of 1.29%. When taking a look at its LTM free cash flow figure of C$2.3 billion, its C$557 million dividend payment looks safe.
Taking a look at its historical dividend payments, we can see that its yield range has remained relatively flat in the past several years.
At 0.8%, the company’s dividend is near the lower end of its range, implying that the stock price is trading at a premium relative to the yields investors have seen in the past. As a result, investors searching for income are better off investing in government bonds.
Risks of Investing in Canadian Pacific
To measure CP’s risk, I will first check if financial leverage is an issue. I do this by checking its debt-to-free-cash-flow ratio. Currently, this number stands at 8.6.
Overall, I don’t believe that debt is currently a material risk for the company because its interest coverage ratio is 7.1 (calculated as EBIT divided by interest expense). In other words, it annual operating income could pay off its annual interest expenses 7.1 times over.
However, there are other risks associated with the company. According to Tipranks’ Risk Analysis, CP has disclosed 25 risks in its most recent earnings report. The highest amount of risk came from the Legal & Regulatory category.
The total number of risks has increased over time, as shown in the picture below.
Wall Street’s Take
Turning to Wall Street, Canadian Pacific has a Moderate Buy consensus rating based on eight Buys and three Holds assigned in the past three months. The average Canadian Pacific price target of C$105.19 implies 10.3% upside potential.
Final Thoughts
The economy continues to rely on railway companies to deliver goods across North America and will continue to do so for a long time. As a result, investors looking to invest in essential businesses may want to consider CP.
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