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Union Pacific Corp
Hunter Harrison is following through on his pledge to instill a “sense of urgency” and “speed things up” at North America’s least-efficient major railroad.
In the past month, Canadian Pacific Railway Ltd. (CP)’s chief executive officer has presided over the exit of two holdovers from his predecessor’s leadership team and started a long-haul service that chops travel times for some freight shipments by as much as a third.
Harrison’s vow on his debut conference call in July was aimed at shareholders betting that he can repeat the turnaround he engineered at Canadian National Railway Co. (CNR) Retired since 2009, the 67-year-old Harrison became William Ackman’s choice to run Canadian Pacific as the New York-based activist investor waged a proxy battle that led to CEO Fred Green’s ouster in May.
“Hunter has a saying: ‘You change a culture one funeral at a time,’ and what we’ve seen in the last couple of weeks are a few funerals,” said Brandon Snow, manager of the C$1.3 billion ($1.33 billion) Cambridge Canadian Equity Corporate Class fund in Toronto, which owns Canadian National shares.
The shares of the Calgary-based railroad surged 18 percent from June 28, the day before Harrison’s hiring, to C$87 on Oct. 12. Canadian National rose 1 percent in that period. Canadian Pacific rose 1 percent to C$87.89 in Toronto, the second session in a row that the stock reached a five-year high.
Harrison’s challenge will be sustaining the recent gains with higher profits. Canadian Pacific’s operating ratio, a gauge of expenses against revenue, was last in North America at 82.5 in the second quarter. That lagged behind the 69.1 average of eight large railroads, based on data compiled by Bloomberg.
The carrier also trailed most North American peers for average train velocity, the data show. On dwell time, the number of hours cars sit in rail yards, Canadian Pacific was ahead of Union Pacific Corp. (UNP), the biggest U.S. railroad, while still short of Canadian National.
Harrison helped drive the “premium” long-distance service announced Sept. 17 to speed container shipments on Vancouver- Toronto and Vancouver-Chicago lines, Chief Marketing Officer Jane O’Hagan said in a telephone interview.
“He felt an urgency to get into the marketplace for the fall, for the peak season, and really pushed the team to act swiftly, to implement a service that we could use to be ready,” O’Hagan said.
Harrison then turned his attention to shuffling his inner circle. Chief Operations Officer Mike Franczak left after seven months in that post and isn’t being replaced “at this time,” the company said Oct. 1. Ten days later, the railroad said Chief Financial Officer Kathryn McQuade would retire on Nov. 1.
“Hunter is getting a hold of the company, he’s shaking it up after many years of lethargic management,” said Michael Simpson, a fund manager at Sentry Select Capital Corp. in Toronto, which oversees about C$8.5 billion in assets and owns Canadian National stock. “He’s going to try to instill his brand of precision railroading at CP.”
At Canadian National and Illinois Central Corp., Harrison’s previous employer, he focused on running shipments and carloads on fixed timetables to ensure reliable deliveries. Maintaining freight schedules has long been an industry challenge.
Efficiency upgrades at Canadian Pacific may take time as some employees resist Harrison’s efforts to overhaul the way the railroad does business, according to Snow, a former industry analyst at Fidelity Investments.
“It’s a battle when you are trying to change the culture,” Snow said in an interview. “The question now is whether people are going to be more defensive. It’s going to be interesting to see as he tries to do what he did at CN -- if he gets more pushback, if it’s more difficult, if it takes longer.”
Walter Spracklin, an RBC Capital Markets analyst in Toronto, said he’s “skeptical” that Harrison can meet his long-stated goal of achieving a 65 percent operating ratio in four years. Harrison reaffirmed that pledge on his July 25 conference call.
Even if Harrison doesn’t hit that target, he still will improve operations and profit, Spracklin said in a telephone interview. He projects earnings per share to be C$3.93 this year and C$5.21 in 2013. The company reported $C3.34 in 2011.
The executive shake-up and service push are “more than symbolic, they’re a bellwether of things to come,” said Spracklin, who has an outperform rating on the stock. “There’s no question they are going to lead to major change at the organization, very quickly.”
Harrison earned a reputation for profit and operational improvements in his seven years running Montreal-based Canadian National. Net income more than tripled, and the operating ratio at Canada’s biggest railroad fell to 67.3 in 2009 from 76 at the end of 2002, filings show.
That record led Ackman, the founder of New York-based hedge fund Pershing Square Capital Management LP, to recruit Harrison as his CEO candidate in the push to dump Green, which succeeded in May. Pershing Square’s stake was 14 percent as of June, based on data compiled by Bloomberg. Ackman didn’t respond to an Oct. 12 e-mail seeking comment on Harrison’s tenure.
Canadian Pacific shareholders will get a chance Oct. 24 to assess Harrison in his new role as the railroad reports results for his first full quarter. Earnings may be C$1.26 a share, the average estimate in a Bloomberg survey of 28 analysts.
A turnaround at Canadian Pacific “could be the most compelling railroad investment opportunity for the next three years,” William Greene, a Morgan Stanley analyst in New York, said in a Sept. 24 note. The carrier’s network “is certainly not broken and arguably has strong potential,” he said.
Greene, who has an overweight rating on the stock, predicts Canadian Pacific’s operating ratio may drop to 72 next year, “with a clear path” toward the “mid-60s” by 2015. One possible source of savings: chopping bills for consultants that probably amount to “tens of millions” of dollars annually, Greene said.
“While the elimination of consultants alone does not fix the operating ratio, it sets a tone for efficiency immediately,” he said.
Harrison, speaking in a July 25 Bloomberg News interview, said longer-term improvements may include a reduction in terminals and a capacity cut of 20 percent to 25 percent in the locomotive fleet over four years.
Simpson, the Sentry Select fund manager, said he would look for evidence of progress on plans to curb capital spending and boost revenue with steps such as charging “more rational pricing.”
Investors “want to see if there’s a good plan to streamline the operations, to manage the network efficiently and win some new business,” Simpson said. “If I see that, if I see better operating ratios, better train speeds, lower dwell time, then I will look at buying the stock.”
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