Railroads company Canadian Pacific Railway is standing out today, surging to $74.83 and marking a 3.9% change. In comparison the S&P 500 moved only 1.0%. CP is -15.03% below its average analyst target price of $88.07, which implies there is more upside for the stock.
As such, the average analyst rates it at buy. Over the last year, Canadian Pacific Railway has underperfomed the S&P 500 by 23.0%, moving -9.0%.
Canadian Pacific Kansas City Limited, together with its subsidiaries, owns and operates a transcontinental freight railway in Canada and the United States. The company belongs to the industrials sector, which generally includes cyclical companies -- with the exception of conglomerates whose business may span several industries. Cyclical companies experience higher sales during periods of economic expanision, and worsening outlooks during recessions.
Canadian Pacific Railway's trailing 12 month P/E ratio is 22.7, based on its trailing EPS of $3.3. The company has a forward P/E ratio of 22.5 according to its forward EPS of $3.32 -- which is an estimate of what its earnings will look like in the next quarter.
The P/E ratio is the company's share price divided by its earnings per share. In other words, it represents how much investors are willing to spend for each dollar of the company's earnings (revenues minus the cost of goods sold, taxes, and overhead). As of the first quarter of 2023, the industrials sector has an average P/E ratio of 22.19, and the average for the S&P 500 is 15.97.
CP’s price to earnings ratio can be divided by its projected five-year growth rate, to give us the price to earnings, or PEG ratio. This allows us to put its earnings valuation in the context of its growth expectations which is useful because companies with low P/E ratios often have low growth, which means they actually do not present an attractive value.
When we perform the calculation for Canadian Pacific Railway, we obtain a PEG ratio of 3.8, which indicates that the company is overvalued compared to its growth prospects. The weakness with PEG ratios is that they rely on expected growth estimates, which of course may not turn out as expected.
To better understand the strength of Canadian Pacific Railway's business, we can analyse its gross profits, which are its revenues minus its cost of goods sold only. The extent of gross profit margins implies how much freedom the company has in setting the prices of its products. A wider gross profit margin indicates that a company may have a competitive advantage, as it is free to keep its product prices high relative to their cost.
CP's gross profit margins have averaged 39.2% over the last four years. While not particularly impressive, this level of margin at least indicates that the basic business model of the company is consistently profitable. These margins are declining based on their four year average gross profit growth rate of -1.8%.
Canadian Pacific Railway's financial viability can also be assessed through a review of its free cash flow trends. Free cash flow refers to the company's operating cash flows minus its capital expenditures, which are expenses related to the maintenance of fixed assets such as land, infrastructure, and equipment. Over the last four years, the trends have been as follows:
| Date Reported | Cash Flow from Operations ($ k) | Capital expenditures ($ k) | Free Cash Flow ($ k) | YoY Growth (%) |
|---|---|---|---|---|
| 2023 | 4,520,000 | 2,305,000 | 2,215,000 | -14.31 |
| 2022 | 4,142,000 | 1,557,000 | 2,585,000 | 19.9 |
| 2021 | 3,688,000 | 1,532,000 | 2,156,000 | 90.63 |
| 2020 | 2,802,000 | 1,671,000 | 1,131,000 | -15.79 |
| 2019 | 2,990,000 | 1,647,000 | 1,343,000 | 15.68 |
| 2018 | 2,712,000 | 1,551,000 | 1,161,000 |
- Average free cash flow: $1.77 Billion
- Average free cash flown growth rate: 11.4 %
- Coefficient of variability (lower numbers indicating more stability): 269.6 %
With its positive cash flow, the company can not only re-invest in its business, it can offer regular returns to its equity investors in the form of dividends. Over the last 12 months, investors in CP have received an annualized dividend yield of 1.1% on their capital.
Another valuation metric for analyzing a stock is its Price to Book (P/B) Ratio, which consists in its share price divided by its book value per share. The book value refers to the present liquidation value of the company, as if it sold all of its assets and paid off all debts.
Canadian Pacific Railway has a P/B ratio of 1.69. This indicates that the market value of the company exceeds its book value by a factor of more than 1, but is still below the average P/B ratio of the Industrials sector, which stood at 4.06 as of the first quarter of 2023.
With an average P/E ratio, a lower P/B ratio than its sector average, and irregular cash flows with an upwards trend, we can conclude that Canadian Pacific Railway is probably overvalued at current prices. The stock presents mixed growth prospects because of its average net margins with a stable trend, and an inflated PEG ratio.
