North South Rail Network Expansion Will Drive Long Term Freight Volume Upside

Catalysts

About Canadian Pacific Kansas City

Canadian Pacific Kansas City operates a unified freight rail network connecting Canada, the United States and Mexico, moving bulk commodities, industrial products and intermodal traffic across North America.

What are the underlying business or industry changes driving this perspective?

• Ongoing integration of the Canadian and U.S. operating systems, PSR discipline and targeted capital on sidings and locomotives are driving higher train weights, better velocity and reduced crew and maintenance costs, supporting continued improvement in operating ratio and net margins.
• Expansion of the north south three country network into underpenetrated Mexico and U.S. South corridors for grain, potash, LPGs and refined fuels positions CPKC to capture share from trucking and short sea, supporting durable volume growth and higher revenue over many years.
• Development of the Meridian Speedway and the CSX connection through Myrtlewood and Montgomery, which enables truck competitive transit times between Dallas, Atlanta and the Southeast industrial corridor, is expected to unlock new industrial and intermodal flows that enhance length of haul, mix and earnings power from 2026 onward.
• Growing automotive, domestic and international intermodal franchises, supported by partnerships with Schneider, CSX and Gemini, and new cold chain capacity at Americold’s Kansas City facility, create a scalable platform to benefit from nearshoring and e commerce logistics needs, lifting revenue and asset turns.
• Robust industrial development and transload pipeline on CPKC owned land, including new facilities in Canada and Mexico and increased land bridge shipments, adds high quality origin and destination points to the network, which should augment carloads, pricing leverage and earnings growth beyond the current grain and potash cycles.

Assumptions

How have these above catalysts been quantified?

• Analysts are assuming Canadian Pacific Kansas City's revenue will grow by 6.5% annually over the next 3 years.
• Analysts assume that profit margins will increase from 28.4% today to 28.7% in 3 years time.
• Analysts expect earnings to reach CA$5.2 billion (and earnings per share of CA$6.16) by about December 2028, up from CA$4.3 billion today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the analysts, the company would need to trade at a PE ratio of 23.5x on those 2028 earnings, up from 21.7x today. This future PE is greater than the current PE for the CA Transportation industry at 19.9x.
• Analysts expect the number of shares outstanding to decline by 3.52% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.48%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• Prolonged macroeconomic weakness across North America, including softer base demand in Energy, Chemicals and Plastics and Forest Products, could pressure volumes in cyclical freight categories and limit the company’s ability to sustain mid single digit RTM growth, constraining revenue and earnings growth.
• Trade policy volatility and tariffs on commodities such as soybeans and cross border steel, along with evolving rules on refined fuels going into Mexico, could disrupt cross border flows and reroute or curtail traffic on key North South lanes, weighing on revenue and operating leverage.
• Rail industry consolidation such as the proposed Union Pacific and Norfolk Southern merger, if approved with favorable conditions, could increase the market power of a large East West competitor, intensify competitive responses at shared gateways and large terminal areas, and ultimately pressure pricing power and net margins.
• Execution risk around network expansion projects like the Meridian Speedway and associated CSX connections, including disputes over train lengths, crew availability, and required capital from partners, could delay the realization of truck competitive transit times and synergies and limit future volume growth and earnings improvement.
• Rising cost pressures from higher depreciation on a growing asset base, increased materials expense tied to long term parts agreements, and potential spikes in casualty costs following derailments could partially offset productivity gains, slowing operating ratio improvement and earnings growth.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The analysts have a consensus price target of CA$121.55 for Canadian Pacific Kansas City based on their expectations of its future earnings growth, profit margins and other risk factors.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of CA$131.0, and the most bearish reporting a price target of just CA$100.0.
  
• In order for you to agree with the analysts, you'd need to believe that by 2028, revenues will be CA$18.1 billion, earnings will come to CA$5.2 billion, and it would be trading on a PE ratio of 23.5x, assuming you use a discount rate of 7.5%.
  
• Given the current share price of CA$102.69, the analyst price target of CA$121.55 is 15.5% higher.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.