EFTA01371111.pdf

31 October 2017 Railroads Canadian Rails Rating Company Buy Canadian Pacific Seldon Clarke Associate Analyst • 1-212-250-5969 North America seldon.clarke(Adb.can Canada NIG," at 30 Oct 2017 IUSDI 174.74 industrials Price Target 209.00 Railroads CPN CPUS 52-week range 177.61 - 139.33 Shifting Gears, Initiate Buy/$209 price Puctfprice NAetivu target Aairi Following its multi-year implementation of Precision Railroading, CP is shifting viv^1.-ytiwee gears from cost take-out to top-line growth. As such, we see at least 15% upside in shares as CP leverages its reduced cost base, improved service levels, and recent capacity investments to retake market share. We expect this to translate to 30% cumulative EPS growth over the next two years, reflecting mid- single digit revenue growth, significant operating leverage, and accelerated share Performance lm 3m 12m I%) repurchase. Against this backdrop we see CP's relative valuation discount as Absolute 4.0 10.7 22.2 unsustainable, which underpins our positive stance to shares. Initiate Buy. TSE 2A 5.8 8.2 Composite CP is putting the pieces together to leverage a better network Sour.* dunes Bart After bringing its cost base closer in-line with CNI, CP has undertaken a number of initiatives aimed at growing its top-line and taking market share. Further, it has ISt..ck Et optl.qt Market Cap IUSDI 25.418.3 made a number of capacity investments in order to improve service levels and Shares outstanding In)) 145.5 more profitably handle volume growth across its network and reinvigorated its Free float f%l 100 sales/marketing efforts to expand existing relationships and win new business. At Volume (30 Oct 2017) 73.246 the end of the day, we believe CP is poised to drive best in class volume growth Option volume (txi. snrs., IM avg.) 42.935 and increase operating leverage as it targets higher margin business. To this point, Sane DetetteM ere we forecast volume growth (measured by revenue ton-miles [RTM's]) to increase at a 3.1% CAGR over the next two years compared to 2.4% CAGR at CM. In addition to CP's company-specific initiatives, we see outsized tailwinds for CP's domestic intermodal, crude by rail, and potash businesses which support our view of best-in-class volume growth. CP's discounted valuation does not reflect earnings potential CP currently trades at 17.5x NTM EPS estimates, which is about 3% below its 5- year avg. and nearly 10% below CNI's current multiple. CP's de-rating (both on an absolute and relative basis) has coincided with a 20% decline in merchandise volumes from 2014 to 2017E while CNI's merchandise ATM's are now back in- line with 2014 levels. Given our expectation for CP to generate best-in-class RTM growth over the next several years, we see potential for shares to re-rate higher as improved operating leverage translates to higher earnings growth. Valuation and risks Our $209 price target is based on 17.5x our 2019 EPS estimate, which is supported by our DCF framework (3.75% terminal growth and 7.9% WACC). Downside risks include a sharp decline in commodity prices, lower pricing, NAFTA, and recession. Page 38 Deutsche Sank Securities Inc. CONFIDENTIAL - PURSUANT TO FED. R. CRIM. P. 6(e) DB-SDNY-0064308 CONFIDENTIAL SDNY_GM_00210492 EFTA01371111