The battle of the Canadian rails between CP Rail (TSX:CP)(NYSE:CP) stock and CN Rail stock heated up in a big way this weekend, as news poured in that CP Rail was to acquire U.S. railway Kansas City Southern (NYSE:KSU) in a cash and share deal worth US$25 billion.
It’s a massive blockbuster deal in the rail scene, and it’ll surely reignite the debate of which Canadian rail stock is the better investment over the long term.
CP Rail’s blockbuster rail deal shakes up the Canadian railway scene
CN Rail boasted the most impressive rail network in North America. It accessed all three North American coastlines, but now there’s a new competitor in town that has access to all three major North American countries.
With Kansas City Southern’s network added to that of CP Rail’s, there’s no question that Canada’s rail kings will be a force to be reckoned with for many decades to come. Canadian Pacific’s moat was already remarkably wide, now it’s absurdly wide, perhaps even wider than its top peer and rival CN Rail.
If the CP-Kansas City Southern deal is approved, CP will become the first rail to span Canada, the U.S., and Mexico. The blockbuster deal reeks of synergies that can be unlocked over the long haul, and it couldn’t come at a more attractive time. Undoubtedly, the deal is exciting, especially with the incredible economic recovery and reopening on the horizon. The new CP Rail would have around 20,000 miles of rail, giving it a network impressive enough to give CN Rail a good run for its money.
“This transaction will be transformative for North America, providing significant positive impacts for our respective employees, customers, communities and shareholders,” said CP Rail CEO Keith Creel.
It’s a big deal that could pay major dividends down the road. That’s for sure.
Should you buy CP Rail stock on the news?
The big deal will give CP Rail an extensive network that would resemble that of CN Rail’s. While I’m a huge fan of the CP-KS Southern deal, I can’t say I’m all enticed by the price tag that CP Rail had to pay, especially at this juncture.
The US$25 billion price tag is undoubtedly steep — a nearly 25% premium over Kansas City Southern stock’s last closing price. One could argue that shares of Kansas City Southern were already quite frothy even before the acquisition premium was slapped on.
Kansas City Southern stock has been on a tear of late, surging 123% over the past year. Before the premium, the stock traded at 7.7 times sales, 21 times cash flow, and 34.2 times trailing earnings, making it one of the pricier rail stocks out there. Analysts were split on the name, with six buys, six holds, and a consensus price target of around US$234. In essence, shares were fairly valued at best. Add a near 25% premium on top of that and CP Rail had better come up with some meaningful synergies to justify its hefty purchase.
Foolish takeaway on the Canadian Pacific’s acquisition of Kansas City Southern
I expect the initial reaction will be negative for CP stock. If shares dip meaningfully, I’d get ready to back up the truck because the railway will have one of the widest moats of any business out there, making it one of the best buy-and-hold-forever stocks on the planet.
I also think CP’s managers will be able to drive enough synergies to justify the high price paid. In any case, I think CP Rail’s top peer CN Rail is a better buy at these levels because shares look cheaper.
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Fool contributor Joey Frenette owns shares of Canadian National Railway. The Motley Fool recommends Canadian National Railway.
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