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Canadian Pacific in Neutral Lane

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We remain encouraged by Canadian Pacific’s (CP - Analyst Report) healthy performance backed by volume addition, safety and efficiency, and cost metrics. Additionally, pricing above inflationary levels (3–4% year-over-year growth) is expected to aid revenue growth in 2012.

We remain optimistic about Canadian Pacific’s freight segment that will continue to support revenue growth in the upcoming quarters. Despite the slump in utility coal volumes, the company expects coal to remain a significant driver owing to its coal transportation deal with Teck Resources Limited. Canadian Pacific is also restructuring its portfolio by replacing the short-haul U.S. thermal coal with long-haul metallurgical coal and has also secured new businesses for shipping Powder River Basin (PRB) through the Ridley Terminal.

In Industrial and Consumer products, growing demand in the oil and gas market is expected to bode well for the company’s Bakken and Alberta oil sands transport business. Management expects the Marcellus Shale natural gas production units and Alberta's Industrial Heartland area, Canada's largest hydrocarbon processing unit, to support revenue and market share gains in energy markets.

Further, Canadian Pacific’s multi-year agreements with companies like Unimin Corporation, Smart Sand, Inc. and U.S. Silica that deal in the energy market also bodewell for earnings growth.In the Grain segment, we foresee growth across Canadian grain crop aided by growth in farming. We also expect continued strong domestic intermodal shipment owing to truckload conversion to rail Intermodal.

The company has assigned long-term investment of nearly C$2.3 billion for 2011–2028 with approximately $1.0–$1.2 billion slated for this year. To  benefit from the current boom in the energy markets the company is building network for shipping frac sand, pipe and construction material as well as other goods required for oil and gas shale production. This would enable easy access to the main production facilities and provide an opportunity to transport large volumes to key shale regions.

However, we remain concerned about the prevailing economic volatility in the U.S. and abroad that may keep Canadian Pacific’s top-line growth under pressure in the near future. Moreover, the near-term growth for the company is expected to be tempered by lower coal production.Lower natural gas prices resulting in weak utility coal market have raised significant concerns limiting overall coal shipments, despite strong exports to Asian countries. In addition, weak U.S. grain shipment due to volatility in feed shipments will remain significant headwinds for the company.

Further, competitive threats from major rivals like Canadian National Railway Company (CNI - Analyst Report), a highly unionized workforce, and regulatory pressures may limit the upside potential of the stock.

Canadian Pacific currently holds a short-term (1-3 months) Zacks #3 Rank (Hold). For the long term, we have retained a Neutral recommendation on Canadian Pacific.

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