EFTA01371087

Deutsche Bank Markets Research North America Canada Industrials Railroads Industry Canadian Rails Flipping the Script - Buy CP, Sell CNI Initiating Coverage of Canadian Rails We are expanding our coverage of Transportation companies with initiation of coverage of the Canadian railroad industry. We are positive on Canadian Pacific (CP, Buy) and cautious on Canadian National (CNI, Sell), as we see overall market share and earnings trajectory driving a reversal in recent relative value trends. All told we forecast CP to grow EPS at double the rate of CNI (+3CP/0 for CP vs. +15% for CNI cumulatively through 2019), which together with capex and free cash trends should drive re-rating at CP and de-rating for CNI. In this report we present a primer on the Canadian rail industry, with deep dives on Canadian Pacific and Canadian National. CANADIAN NATIONAL (CNI): A Victim of Its Own Success; Initiate SeIl$73 PT We see 10%+ downside in CNI shares as the company's strong outperformance starts to slow- driven by both the law of large numbers (the company already achieves a mid 40's operating margin, up from the high 30's five years ago) as well as catch-up performance from CP. For example, we note that from 2012-2016 CNI increased volumes at more than double the rate of CP, reflecting mix as well as market share gains during CP's implementation of Precision Railroading. The combination of CNI's slower prospective earnings growth and high capex (20% of sales) implies 15.5x PIE under our DCF-derived methodology, implying potential for 3.5 turns (20%) valuation de-rating vs. current trading levels. Initiate Sell. CANADIAN PACIFIC (CP). Shifting Gears: Initiate Buy:$209 PT Following its multi-year implementation of Precision Railroading, CP is shifting 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 repurchase. Against this backdrop we see CP's relative valuation discount as unsustainable, which underpins our positive stance to shares. Initiate Buy. Valuation and Risks: We utilize P/E multiples to value rail stocks, with our target multiple assumptions heavily supported by our discounted cash flow models. Risks for the group include recession, industrial production, pricing, and mgmt. execution. For more details please company-specific CP and CNI sections within this note. Date 31 October 2017 Initiation of Coverage Station Chfi31, CFA Associate Analyst +1.212.2605969 Amlt Mehrotra Research Analyst +1.212-2502076 Mnya Vial4ou Research Associate +1-212-260-7164 Olds Soyd4l CFA Research Associate +1.212.250-O165 ICumpuntat iwiore.1 Canadian Pacific (CP.N4USD1 / 4 /4 Canadian National (CHI.14).USD81 21 Sown Doman Bare Buy Sell Deutsche Bank Securities Inc. Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX I . MCI (P) 083/04/2017. CONFIDENTIAL - PURSUANT TO FED. R. CRIM. P. 6(e) CONFIDENTIAL DB-SDNY-0064271 SDNY_GM_00210455 EFTA01371087