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Is CP Rail activist plan much ado about nothing?

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There is no doubt Canadian Pacific Railway has room to pump up its performance, but the market is not convinced that an activist shareholder will get results any quicker than the railroad's own plans.

A number of obstacles lie in the way of quickly cutting costs and boosting revenue at Canada's second biggest railroad, analysts say, including a steep pension bill, long-term sales contracts and the location of its tracks.

Other quick fixes such as asset sales are not an option as CP doesn't have non-core divisions and its real estate holdings are central to its rail operations.

"We don't think that they can move the goalpost significantly from what has been already outlined by management," said BMO Capital Markets analyst Fadi Chamoun.

Shares in CP are down nearly 2 percent since Pershing Square Capital Management, run by activist shareholder William Ackman, revealed last Friday it had spent more than $1 billion buying shares in the 130-year-old railway.

To be fair, CP's shares had run up 38 percent in the six weeks that Pershing was buying its 12.2 percent stake in the company, which makes it the railroad's biggest shareholder. But the disclosure of the buyer's identity has not led to a follow-on rally.

Ackman is best known for investing in retail companies and pressuring their boards to improve operating performance. Some have questioned how much he knows about the rail industry.

He has not said what his plans are for CP, although he did tell Bloomberg news this week that he does not think it should be sold.

PRODUCTIVITY IMPROVEMENTS A SLOW-MOVING TRAIN

Boosting productivity is not going come quickly for CP, which has the weakest operating metrics of the North American Class 1 railways and the highest debt-to-equity level.

For one, its tracks are in more challenging terrain than those of its bigger, more efficient domestic rival, Canadian National Railway Co.

Steeper grades mean extra fuel expense, slower train speeds and bigger problems when bad weather strikes, as it did last winter. CP's tracks are also in areas of more competition from trucks compared with CN's, which are further north.

"You can't just change where your tracks run," National Bank Financial analyst Cameron Doerksen said.

Another barrier to a quick profitability improvement is its annual employee pension service bill. This year, CP will pay $46 million into the fund, $125 million in 2013.

Safety requirements, a highly unionized workforce and regulatory oversight also make for slow change, said RBC Capital Markets analyst Walter Spracklin.

On the revenue side, raising revenues quickly is hampered by long-term contracts entered into with shippers.

OWN PLAN

CP's management has laid out a three- to five-year game plan to improve productivity at the railway, which operates a 14,000-mile (22,400 km) network across Canada and into the United States.

Most of the big North American railroads have already gone through slow, decade-long turnarounds that improved their operating performance.

"We've frequently called CP the last train for the turnaround theme," Jefferies analyst Peter Nesvold said in a note to clients.

CP's plan includes longer trains and sidings and investing in infrastructure corridors where there are bottlenecks. It also hired a new head of operations from rival CN although he retired after a year.

CP's goal is to improve its operating ratio, a measure of expenses relative to revenue, to the low 70 percent range from near 80 percent now over the next two to four years. The lower the ratio, the more efficient the railroad. CN's is 59 percent.

CP is also targeting an operating margin of 30 percent in three to four years, up from 20 percent now.

To help it meet its targets, the railroad plans to spend about $1 billion in each of 2011 and 2012. The capital is badly needed after years of underinvestment in its network, according to Sterne Agee analyst Jeffrey Kauffman.

"They're currently in the process of fixing that, but it's not as simple as somebody coming in, buying up stock, saying I want a change in management, and then voila it's fixed," Kauffman said.

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