CP Rail Chief Harrison Favors Buyback Over Dividend Increase

Feb 19, 2014 4:38 pm ET

(Updates shares in ninth paragraph.)

Feb. 19 (Bloomberg) -- Canadian Pacific Railway Ltd. is leaning toward implementing a stock buyback this year, a nod to the needs of U.S. investors, along with a “modest” dividend increase, Chief Executive Officer Hunter Harrison said.

“Certainly before the year is out, maybe sooner than later, we will do a buyback,” Harrison said yesterday in a telephone interview from Calgary. A possible dividend increase is “a little more sensitive because U.S. holders are not crazy about dividends because of the tax treatment. U.S. investors would rather have a buyback than a dividend.”

No decisions have been reached on the amount of a stock- repurchase plan, and a buyback wouldn’t necessarily rule out a dividend boost, Harrison said. The Calgary-based railroad last raised its quarterly payout, to 35 cents, in April 2012.

U.S. funds control about 72 percent of the stock, more than triple the 20 percent for Canadian holders, based on data compiled by Bloomberg. New York-based activist hedge-fund manager William Ackman is the largest shareholder with a stake of about 9.7 percent as of last month, the data show.

U.S.-resident corporate taxpayers receiving dividend income from Canadian companies probably would be taxed at a 35 percent rate at the federal level, said Nik Diksic, a partner in international tax services at Ernst & Young LLP in Montreal. Their Canadian counterparts probably wouldn’t pay any tax because inter-Canadian company dividends are generally tax-free, Diksic said.

2014 Forecast

Canada’s second-largest carrier predicted last month that adjusted 2014 earnings will rise at least 30 percent from a base of C$6.42 a share, implying profit of at least C$8.35. After the company disclosed cash and near-cash items of C$476 million ($435 million) at the end of 2013, Chief Financial Officer Bart Demosky told investors Jan. 29 he is “not a fan of sitting on idle cash.”

“There might be a case made for a modest increase in the dividend, and a little more aggressive buyback,” Harrison said. “I’ve not heard the various views at the board level, but clearly this is an issue we’re onto. We’re keen. We need to make some decisions rather quickly there.”

Canadian Pacific may be able to buy back as much as 3 percent to 5 percent of its stock a year, said Scott Group, an analyst at Wolfe Research in New York. A 3 percent repurchase program would cost about C$904 million, based on yesterday’s closing price and 175.5 million shares outstanding, according to data compiled by Bloomberg.

Shares Rise

Canadian Pacific rose 0.6 percent to C$172.77 at the close in Toronto. The stock more than doubled since Harrison took the helm, outstripping the 22 percent increase in Standard & Poor’s/TSX Composite Index, the main gauge of Canadian equities.

“Everything so far about CP under the new management team has been bigger and better than expected,” Group said in a telephone interview. “My sense if that they are going to come out with a very large buyback, and I’m guessing it will be a multi-year buyback.”

Harrison, 69, was hired in 2012 after Ackman engineered a boardroom coup to oust then-CEO Fred Green, and his efforts to improve efficiency are bearing fruit. The railroad’s operating ratio -- an industry benchmark that compares expenses to revenue -- declined to 76.8 percent in 2013 from 81.3 percent in 2011, Green’s last full year at the helm.

Operating Ratio

On an adjusted basis that excluded some items, last year’s ratio was 69.9 percent. While Canadian Pacific said last month it’s targeting a ratio of 65 percent or less in 2014, Harrison said yesterday the railroad may do even better as revenue climbs and he wrings out efficiencies with steps such as running longer trains.

“We’ve given guidance of 65 or below, but my personal view is that if things work well and we get a few breaks here and there, we could do 63,” said Harrison, who ran Canadian National Railway Co., the country’s biggest railroad, from 2003 through 2009.

Within two years, that figure may be “someplace in the low 60s,” Harrison said. That would cap a turnaround for the railroad that once had the highest such ratio among its peers in North America.

Harrison said crude-by-rail shipments aren’t a decisive business at Canadian Pacific, accounting for less than 5 percent of 2013’s C$6.13 billion in revenue. Those cargoes have been a focus for regulatory scrutiny after accidents including the disaster in Lac-Megantic, Quebec, that killed 47 people when oil cars hauled by a short-line carrier derailed and exploded in July.

“We live up to the rules and regs, and I pray every night that there are no incidents,” Harrison said. “Having said that, I want to make it clear that the success and the future of Canadian Pacific is not tied to crude at all.”

--Editors: Ed Dufner, Stephen West