TOM SLEE'S UPDATES

Brainteaser

TOM SLEE'S UPDATES on Canadian National Railway, Burlington Northern Santa Fe, Potash Corporation of Saskatchewan, SNC-Lavalin


CN Railway (TSX: CNR, NYSE: CNI)

Originally recommended on May 6/02 (IWB #2218) at C$25.95 (split-adjusted). Closed Friday at C$55.50, US$51.61.

CN reported a respectable third-quarter profit and money managersheaved a sigh of relief. The nation's major railway is a barometer forthe economy and any unpleasant surprises could have stalled the stockmarket recovery. In the event, CN racked up operating earnings of 97c ashare, down from $1.07 a year ago but ahead of the 89c per share thatanalysts were expecting.

The really good news, though, is in the top line numbers vis-à-vis thesecond quarter. Carload volumes were up 11% and revenue ton miles up 4%over the previous period. That prompted outgoing CEO Hunter Harrison tosay that he thinks the worst is behind us. He went on to point out thatthe latest weekly freight statistics also show a slow but steadycomeback. Then, as if to demonstrate his confidence, Harrison ordered70 new locomotives as part of a $1.5 billion capital expenditureprogram.

It all sounds very encouraging. When you study the third-quarternumbers, however, there are still some big question marks. Our robustloonie is creating a strong headwind for CN. This time last year theC$/US$ exchange rate was 83c per U.S. dollar. Today, as you know, weare approaching parity. A one cent difference in foreign exchange costsCNR about two cents in earnings. It's a vivid example of the problemfacing all Canadian companies.

CN is also facing lower grain rates. Auto and lumber shipments remain soft.

That having been said, the company is now lean and mean. It isgenerating solid cash flow and has a strong balance sheet. Anyimprovement in business will spur earnings. We could see a profit of$3.40 a share this year followed by as much as $4 in 2020.

Action now: CN Railway remains a Buy at $55.50 with an increased target of $65. I will revisit the stock if it dips to $48.

Burlington Northern Santa Fe (NYSE: BNI)

Originally recommended on May 12/08 (IWB #2818) at $103.47. Closed Friday at $97.23. (All figures in U.S. dollars.)

Burlington Northern also turned in better than expected third-quarterresults. Operating earnings were $1.36 a share, a sharp drop from $1.91in 2008 but more than the $1.28 consensus estimate. Here again therewere clear indications that the second quarter of 2009 may have beenthe bottom. Carloads were up almost 5% and average revenue per carloadincreased 3.4% quarter-over-quarter. Total revenues jumped more than 8%from the second quarter. The trend is in the right direction -certainly Warren Buffett thinks so.

In an unexpected move, Buffett's company, Berkshire Hathaway, whichalready owns 22.6% of Burlington Northern Santa Fe, is offering to buythe rest of the railway for $26 billion. The bid is a littlecomplicated and provides for each share of BNI to be converted into$100 cash or an equivalent amount of Berkshire stock subject to a"collar", whereby the value of each Berkshire share received is fixedat $100. In addition, the entire deal is 60% cash and 40% stock andsubject to proration. In other words, you may elect to receive all cashbut end up with some Berkshire stock if most people want their money.The deal is expected to close in the first quarter of 2010.

My suggestion is that unless you really want to take a position inBerkshire, it's best to opt for all cash and sell any shares that youreceive. Otherwise, you are going to end up with an odd stake in whatis essentially Buffett's personal corporation. That may not be a badthing (in fact, Berkshire Hathaway is an active IWB recommendation) butit's always best to consciously buy equities after some basic researchrather than acquire them through a takeover. The bid itself,incidentally, is very attractive. A price of $100 a share is a 31%premium to the market and 7.5% above our $93 target for BNI. There isno possibility of a competing offer.

Personally, as a firm believer in railways, I am sorry to seeBurlington disappear. Trains are increasingly efficient, climatefriendly, surprisingly responsive to computers, and have locked-inmarkets. Most important, they are not building any new railways.

So I am proposing to replace BNI on our list of recommendations withNorfolk Southern Corp. (NYSE: NSC) currently trading at US$52.07.Third-quarter earnings beat expectations and we should see a profit ofabout $2.80 a share this year with an improvement to the $3.75 range in2010. I will provide a full analysis next time.

Action now: Tender Burlington Northern shares for cash at $100. Buy Norfolk Southern at $52.07.

Potash Corporation of Saskatchewan (TSX, NYSE: POT)

Originally recommended on Jan. 28/08 (IWB #2804) at C$133.98, US$132.74. Closed Friday at C$103.75, US$96.25.

Over at Potash Corp., the third-quarter numbers and resulting guidancewere both very disappointing. The world's largest potash producerearned 82c a share (the company reports in U.S. currency) versus aconsensus forecast of 81c. That was at the bottom of management'srevised projection of 80c to $1.20 issued as late as September. A yearago, Potash made $3.93 a share.

In fairness, investors had braced themselves for some bleak results.Faced with a global slump, farmers are deferring purchases as long aspossible. People were, however, shocked by CEO Bill Doyle's depressingforecast. He admitted that his predictions have been consistently wrongand he is now not sure when we will see an improvement in demand.Global exports of potash fell 72% in the first six months of this year.

My concern is that management no longer seems to have a grip on thesituation. At the same time, it's interesting that the stock actuallystrengthened on the day Doyle spoke.

There are persistent rumours, fuelled by the Bank of America, about abid by BHP Billiton Ltd. for the company. A price of US$125 a share hasbeen mentioned but this is pure speculation. Based on fundamentals, theStreet has a C$115 target on the stock. I would postpone any newcommitments.

Action now: Potash Corp. remains a Hold.

Toromont Industries (TSX: TIH, OTC: TMTMF)

Originally recommended on Aug. 31/09 (IWB #2932) at C$22.68. Closed Friday at C$26.24, US$23.75.

Toromont Industries had a reasonably good third quarter although manyinvestors were unhappy with a 26% year-over-year drop in revenues.Actual earnings came in at 49c a share versus 56c in 2008 but wellabove the mean estimate of 45c. The truth is that people were hopingToromont's sales would reflect an improvement in the Canadianconstruction industry. Instead, management reported that this businesswas stable.

The big news here is that the company has made an unfriendly bid forEnerflex Systems Income Fund, a supplier of equipment to the oil andgas industry. The deal is going to cost Toromont $597 million, half incash, but it could add as much as 20c a share to earnings in 2010 andbeyond. Assuming that the purchase is completed, we could see a profitof about $1.75 a share in 2009 followed by close to $2 next year.Indications are that while the third quarter was the bottom of thiscycle for the equipment industry there is going to be no snap back. TIHshould participate fully in a steady but unspectacular recovery.

Action now: Toromont remains a Buy at $26.24 with a revised target of $29. I have set a $20 revisit level.

SNC-Lavalin (TSX: SNC, OTC: SNCAF)

Originally recommended on May 8/06 (IWB #2618) at C$32.45. Closed Friday at C$47.35, US$40.62 (Oct. 30).

SNC-Lavalin is due to report shortly and I will update in detail thestock next time. For now, though, the company is firing on allcylinders and we should see earnings of at least $2.40 a share in 2010.The stock is now trading at $47.35, up 46% from our originalrecommendation and well through its $38 target.

Action now: The shares still have upside potential and remain a Buy with a new target of $53.