SLCA Silica Holdings Inc

Canadian Pacific Railway Limited (CP) has inked a multi-year deal with U.S. Silica Holdings, Inc. (SLCA). According to the agreement, Canadian Pacific will exclusively provide freight solutions for shipping frac sand from U.S. Silica’s new facility in Wisconsin. U.S. Silica – the second largest domestic commercial silica maker – is setting up a new frac sand mining and processing facility to connect with Canadian Pacific’s rail network in Sparta, Wisconsin. The production facility is expected to begin operations in the first quarter next year.

Given the fact that Canadian Pacific is the only railroad that connects to Bakken, Alberta Industrial Heartland and the Marcellus Shale region, the increasing opportunity for energy products in these regions will also remain accretive for to Canadian Pacific’s business. Higher movements of petroleum products, natural gas and frac sand for drilling activities open up lucrative opportunities for Canadian Pacific.

The company had previously projected that the Marcellus Shale natural gas production unit and Alberta's Industrial Heartland, Canada's largest hydrocarbon processing unit, to support its revenue through higher shipments in the upcoming years.

Additionally, Canadian Pacific’s plans to improve train lengths and network in 2012–2013 will also support its new business opportunities. This year, the company intends to upgrade and install new sidetracks in key areas to support increased train length.

Further, in 2013, Canadian Pacific plans to increase train length by 11% on the trans-Canada rail routes. Enhancement of network capabilities over the next couple of years remain concurrent with its goal of enhancing capacity, safety and service metrics as well as increasing fuel efficiency by 1–2% over the long term.

Since 2008, Canadian Pacific’s intermodal trains have grown by 40% to approximately 12,000 feet. Longer trains have resulted in increased efficiency in terms of capital inputs and have enabled the company to tap potential opportunities in the rapidly growing rail freight market.

Further, we believe that the company’s decision to improve train length remains a key strategy given the emergence of new markets for rail intermodal services due to uncertainties surrounding truck freight. Additionally, growth in export coal and potash shipments along with the recent development in crude shipment has propelled the company to expand its capacity via longer trains.

To support these growth plans, Canadian Pacific projects long-term capital expenditures of nearly C$2.3 billion for 2011–2028, with an approximately $1.0–$1.2 billion budget for the current year.

Although these initiatives look attractive for long-term growth and provide a competitive advantage over railroads like Canadian National (CNI), which operates on almost similar tracks, we believe heavy investments in new locomotives, technology and fuel recovery initiatives overlook the current economic outlook and stressed operating metric due to soaring fuel prices, thereby paving way for distressed margin performance in the near term.

Consequently, we maintain our long-term Neutral recommendation on Canadian Pacific supported by a short-term Zacks #3 Rank (Hold).

 
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