OTTAWA -- Although Canadian Pacific Railway Ltd.'s stock has been moving full steam ahead, some analysts caution that it may veer off track over the near term, the Globe and Mail reports.

Shares of the Calgary-based railway company, one of five spinoffs of the former Canadian Pacific Ltd., formally started trading on the Toronto Stock Exchange Oct. 3. By the end of the year, the stock had risen 32 per cent to close at $32.10; it has risen further since.

CPR's stock closed yesterday at $33.95, up 4 cents or 0.12 per cent.

North American rail stocks, including CPR's, have shown tremendous growth over the past few months, outpacing broader indexes. But analysts say they are now concerned about the high valuation levels and the companies' exposure to the coal and grain markets.

Robert Fay, an analyst at Canaccord Capital Corp., said the rail industry is made up of six major players. At the same time, Mr. Fay says he's concerned with the degree of exposure rail stocks, particularly CPR and its Canadian competitor, Canadian National Railway Co., have to the grain markets.

Drought conditions in Western Canada have already hampered shipments. Furthermore, a hot, dry summer in the Prairies and the U.S. Midwest could create more problems for rail companies, he added.

"I'm a little worried that [declining grain shipments are] going to continue for the next couple of quarters," Mr. Fay said, adding that a slowdown would offset any lift from the North American economy over all.

When CPR released its 2001 earnings earlier this year, president and chief executive officer Robert Ritchie said revenue growth was hindered by the slowing economy, lower Canadian grain shipments and weak demand for sulphur and fertilizers.

For investors betting on an economic recovery, Mr. Fay recommends CN, saying the company has less exposure to the grain and coal markets. Although CPR is increasing its forest products shipments and its intermodal traffic -- an indicator of consumer products being shipped -- it is still heavily involved in the agricultural and coal businesses, Mr. Fay said.

The analyst has a "market perform" rating on CPR, with a 12-month target price of $34.

Railway stocks tend to perform well over the long term, Mr. Fay said, but their valuations are high right now. This is a concern shared by many analysts.

Fadi Chamoun, an analyst at UBS Warburg Inc., said the current cyclical rally is pushing rail stocks toward their historical highs with respect to valuations.

In a recent research note to clients, Mr. Chamoun said that since 1993 the average enterprise value (a company's market capitalization plus its debt) over EBITDA (earnings before interest, taxes, depreciation and amortization) for the rail sector has ranged from six to eight times, with an average of seven through the cycle.

CPR is trading at an enterprise value of 7.2 times Mr. Chamoun's 2002 EBITDA forecasts. While this is relatively high, it is cheaper than CN, which is trading at 8.6 times.

"We believe CPR's low relative valuation provides a potential buffer for its stock price in the event that earnings disappoint and/or if valuation multiples compress," Mr. Chamoun said. "As such, we view CPR as the safest opportunity in the sector."

Mr. Chamoun has a "buy" recommendation on the stock with a 12-month target price of $39 a share.

An improving balance sheet, lower fuel prices, substantially improved service levels and an economic recovery should support earnings growth for the rail sector over the next two years, Mr. Chamoun said. He said he believes CPR will see its earnings improve and its operating ratio lowered.

However, like other analysts, Mr. Chamoun said there are concerns surrounding the rail sector over the short term, particularly weakening coal volumes.

The rail sector was helped by record coal transportation in 2001 as the U.S. economy entered a recession. This was driven by high natural gas prices and low coal stockpiles, a very different situation than today, Mr. Chamoun said.

Furthermore, a warmer-than-normal winter has led to surplus coal inventories at electricity plants, the railways' largest coal clients, he said.

Until these utility companies run down their excess stockpiles, this could lead to some downward earnings revisions for rail companies, Mr. Chamoun warned.

However, 95 per cent of CPR's coal business consists of metallurgical grades used in the steel-making process, Mr. Chamoun said, and he expects demand to remain firm.

Another problem facing the rail sector and CPR is the potential for a "multiple compression" as investors start shifting money into higher growth sectors as the economy improves.

"Given our outlook for an economic recovery by the second half of this year and into 2003, we believe valuation multiples might come under pressure," Mr. Chamoun said. "We expect, however, that this will be short-lived given our belief that the sector's fundamentals will support current valuation in the medium to long term."

Like other analysts, James Valentine, an analyst with Morgan Stanley Dean Witter & Co., believes CPR is one of the cheaper names in the railway sector. He also feels that rail stocks will come under increased pressure this year because traffic has been relatively weak, and coal and grain volumes are "down sharply," following a strong 2001.

Mr. Valentine has a "neutral" recommendation on CPR shares.

"If current traffic trends don't improve, we may need to lower our [earnings-per-share expectations] further," he said in a note to clients. "But with this said, [CPR] is one of the cheaper names in the sector . . . and therefore can be considered a potential rail holding by investors who insist on having exposure to the sector."