Is Canadian Pacific Kansas City Stock a Buy?

FREIGHT TRAIN

Railroad companies were key to the initial investment booms in Canada and the U.S. Over 100 years later; railroads are a crucial part of the economy in North America. In the last few decades, the railroad industry has consolidated, and the sector is currently dominated by a handful of giants.

While trucking and shipping consignments were disrupted amid COVID-19, railroads fared much better due to a unique business model and an ability to move large volumes of cargo with fewer people.

Most transportation stocks are cyclical, but railroad companies enjoy several competitive moats, allowing them to benefit from stable cash flows even amid economic downturns. While this sector wrestled with bankruptcies in the last century, today, an entrenched position allows railroad companies to enjoy robust balance sheets, steady profit margins, and a widening earnings base.

One such quality railroad company is Canadian Pacific Kansas City (TSX:CP), which has returned 263% in the last 10 years and 1,860% in the last 20 years after adjusting for dividends. Trading at all-time highs, CP stock is valued at $105 billion by market cap. Let’s see if CP stock can continue to deliver market-beating returns for shareholders in 2024 and beyond.

An overview of Canadian Pacific Kansas City

Canadian Pacific Kansas City, or CPKC, is the first and only single-line transition railway linking Canada, the U.S., and Mexico. It has access to major ports from Vancouver to Atlantic Canada to the Gulf of Mexico.

Its rail network stretches around 20,000 route miles, and the company employs more than 20,000 people to ship a variety of goods across North America.

How did CPKC perform in Q4 of 2023?

In the fourth quarter (Q4), CPKC reported revenue of $3.8 billion, an increase of 4% year over year. Its volumes also grew by 4% while the company improved its operating ratio by 220 basis points to 58.7%, resulting in a 4% growth in earnings. In 2023, CPKC increased sales by 5%, while volumes rose by just 1%. With an operating ratio of 62%, CPKC increased earnings by 3.84% in 2023.

Since the acquisition of Kansas City, CPKC has launched new services and market solutions, unlocking another revenue stream. In the last year, the combined entity has improved operating efficiencies, reduced its asset base, and increased velocity.

CPKC reported operating cash flow of $1.3 billion and free cash flow of $785 million in Q4. Given it pays shareholders a quarterly dividend of $0.19 per share, CPKC paid $177 million in dividends, indicating a payout ratio of less than 25%, providing the company with enough room to reinvest in growth and target accretive acquisitions.

Its low payout ratio also allows CKPC to increase dividends over time. In the last 18 years, CPKC has raised the dividend by 10.8% annually, showcasing the resiliency of its cash flows.

Earnings growth to continue

CPKC ended 2023 with $2.2 billion in free cash flow and a leverage ratio of 3.4 times. It aims to use a portion of its cash flow to reduce balance sheet debt and expects to end the year with a leverage ratio of 2.5 times.

CPKC expects to allocate $2.75 billion in capital expenditures this year, allowing it to increase earnings from $3.84 per share in 2023 to $5.24 per share in 2025. Priced at 21.4 times forward earnings, CP stock might seem expensive. But the TSX giant is forecast to grow earnings at an enviable pace in the next five years.

Should you invest $1,000 in Canadian Pacific Railway right now?

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Fool contributor Aditya Raghunath has no position in any of the stocks mentioned. The Motley Fool recommends Canadian Pacific Kansas City. The Motley Fool has a disclosure policy.