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What Drags Down Canadian Pacific Shares?

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When activist investor William A. Ackman announced his plans to sell Canadian Pacific Railway Limited (CP - Free Report) shares earlier this week, the stock slipped significant with shares trading as low as $124.47 on Tuesday. According to the announcement, Ackman will reduce his ownership by selling around 7 million common shares, spread over a 12-months period, beginning June. Is Ackman’s announcement the only reason for the slide or there is any other side to this story?

Ackman attributed the reason to his decision to reduce his holding in the company to this substantial rise. In the press release, Ackman stated that Canadian Pacific represents approximately 26% of the combined assets of his funds. Given high risk factors from the standpoint of portfolio management, it was imperative to let go off some of his holdings.

Given the exponential rise in Canadian Pacific shares since 2011, the stake reduction seems to be a strategic decision by Ackman as it allows him to gain from the price appreciation (over 200% since 2011). Ackman, the founder and CEO of hedge fund Pershing Square Capital Management, L.P. bought around 12.2% stakes in Canadian Pacific in Nov 2011, following which he introduced many investment and strategic changes in the company that resulted in significant turnaround in its market value.

One of his key strategies was to bring changes in management including appointment of a new CEO. In Jan 2012, Ackman proposed to replace CEO Fred Green with Hunter Harrison, who was the former CEO of rival Canadian National (CNI - Free Report) . This decision was approved despite being highly condemned.  

Following these changes, the company registered remarkable growth in its share price. This growth was also supported by market forces such as a downtrend in the truck market, price recoveries and increase in crude by rail shipment as well as a rise in auto production that acted as long-term catalysts. Overall, we can conclude Ackman and his policies have worked in favor of the company bringing it to new highs.

Having said this, we wonder that if portfolio readjustment is the only reason why Pershing Square is giving up stakes in a high potential stock, which tripled in its market value in past one year. Canadian Pacific is experiencing financial growth from volume addition, safety, efficiency and, cost metrics. Additionally, pricing above inflationary levels (3–4% year over year growth) is expected to aid revenue growth in 2013 and beyond.

Further, Canadian Pacific remains committed to generate an operating ratio around 65.0% by 2016. Despite all these favorable projections, we suggest that Ackman’s stake sale could itself be a possible indication to a downside risk to the company valuation.

Even if the significant growth going forward could not lure activist, Ackman from holding up his position in the company, we wonder what this could possibly imply for the general investors of the company. Will the stock continue with the downtrend going by current signals or will it bounce back based on its near-term financial projections is something to wait and watch out.

Canadian Pacific, which operates with other players like Union Pacific Corporation (UNP - Free Report) and Kansas City Southern (KSU - Free Report) carries a Zacks Rank #3 (Hold)

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