Canadian Pacific Kansas City Limited — Q2 2023 Form 10-Q
Reporting period: Three and six months ended June 30, 2023. Amounts are in Canadian dollars unless stated otherwise. Results include Kansas City Southern (KCS) as a consolidated subsidiary from April 14, 2023; before that date, KCS was accounted for as an equity investment. This limits direct comparability with 2022.
Business context and financial performance
CPKC operates an approximately 20,000-mile freight rail network serving Canada, the United States and Mexico. The April 14 control of KCS created a single-line railway linking the three countries.
| Metric | Q2 2023 | Q2 2022 | First half 2023 | First half 2022 |
|---|---|---|---|---|
| Revenue | $3.174 billion | $2.202 billion | $5.440 billion | $4.040 billion |
| Operating income | $944 million | $868 million | $1.773 billion | $1.403 billion |
| Net income attributable to controlling shareholders | $1.324 billion | $765 million | $2.124 billion | $1.355 billion |
| Diluted EPS | $1.42 | $0.82 | $2.28 | $1.45 |
| Core adjusted combined diluted EPS (non-GAAP) | $0.83 | $0.95 | $1.73 | $1.62 |
| Operating ratio | 70.3% | 60.6% | 67.4% | 65.3% |
| Core adjusted combined operating ratio (non-GAAP) | 64.6% | 60.3% | 64.0% | 63.3% |
| Cash provided by operating activities | $892 million | $707 million | $1.774 billion | $1.320 billion |
Q2 revenue rose 44%, primarily reflecting $979 million of freight revenue from the KCS acquisition, higher freight revenue per revenue ton-mile and stronger Canadian grain volumes. Freight revenue per revenue ton-mile increased 16%; carloads rose 50% and revenue ton-miles rose 24%. Potash, U.S. grain, and some energy-related volumes were weaker. The Q2 operating ratio increased 970 basis points year over year; the core adjusted combined ratio increased 430 basis points. Management cited acquisition-related costs, purchase-accounting effects, operating inefficiencies and lower average train weights. Fuel efficiency worsened 11% in Q2.
Liquidity, debt and capital resources
- Cash and cash equivalents were $325 million at June 30, 2023, versus $451 million at December 31, 2022. Operating cash flow for the first half was $1.774 billion; property additions were $1.034 billion, with an additional $8 million for Meridian Speedway properties.
- Total long-term debt, including amounts maturing within one year, was $23.262 billion, compared with $19.651 billion at year-end. The company repaid maturing notes and had $536 million of commercial paper outstanding, carrying a weighted-average rate of 5.41%.
- The revolving credit facility was increased to US$2.2 billion, extended to May 2028 for its five-year tranche and May 2025 for its two-year tranche, and was undrawn at quarter-end. CPKC reported compliance with its financial covenant. Commercial paper capacity was increased to US$1.5 billion on July 12, 2023.
- Management stated that cash, operating cash flow and available borrowing capacity were adequate for expected requirements, and that it knew of no material liquidity deficiency. Credit ratings were BBB+ (S&P) and Baa2 (Moody’s), both with stable outlooks.
Material changes, unusual items and outlook
- Reported Q2 net income and EPS are significantly affected by acquisition accounting and tax items. CPKC recognized a $7.175 billion loss on remeasurement of its previously held KCS investment, largely offset in reported earnings by a $7.832 billion deferred tax recovery from derecognizing the related outside-basis deferred tax liability. The resulting tax recovery was $7.672 billion for Q2. The filing’s non-GAAP core adjusted measures exclude significant items and KCS purchase accounting.
- CPKC recorded $119 million of acquisition-related costs in Q2 and $134 million in the first half. Reported Q2 KCS revenue and net income attributable to controlling shareholders from April 14 to June 30 were $998 million and $138 million, respectively. Purchase-price allocation remains provisional and may be adjusted during the measurement period of up to one year; recorded KCS goodwill was $17.491 billion at acquisition.
- Management expected the 2023 core adjusted effective tax rate to be approximately 25.50%, excluding specified discrete items and KCS-related effects. The filing does not provide a clear broader full-year revenue or earnings guidance figure in the supplied text.
- The STB approved the merger subject to conditions, including open-gateway commitments, environmental requirements, reporting obligations and seven years of oversight. Management cautioned that integration may be difficult and anticipated benefits are not assured. A proposed CPKC-CSX-G&W interchange corridor in Alabama remains subject to regulatory review or approval.
- Contingencies include appeals of the dismissal of major Canadian claims related to the Lac-Mégantic derailment; management says potential responsibility and losses cannot currently be determined. A separate Alberta property-claim judgment estimated at approximately $200 million before costs is under appeal, and CPKC cannot yet reasonably estimate its share. A Mexican 2014 tax assessment is approximately $428 million and remains in litigation. Environmental remediation provisions were $228 million at quarter-end.
- The EPA and DOJ are discussing alleged locomotive-related Clean Air Act noncompliance; no final violation determination or preliminary civil penalty assessment had been issued as of the filing. CPKC also disclosed risks related to Mexico’s rail concession, currency and trade exposure, merger conditions, integration, labor, safety and operating disruptions.
Investor verification priorities
- Assess underlying performance using the reconciliations and assumptions behind core adjusted combined EPS and operating ratio, rather than reported EPS alone.
- Track KCS integration, realization of expected merger benefits, STB conditions and the development of provisional purchase accounting and goodwill.
- Review debt maturities, commercial-paper balances and borrowing costs, capital spending, and cash generation against the enlarged debt base.
- Monitor the outcomes and potential financial exposure from the Lac-Mégantic appeals, Remington appeal, Mexican tax matters, environmental liabilities and Clean Air Act inquiry.
- Evaluate volume, pricing and operating trends, including weaker product-specific volumes, lower train weights, fuel efficiency and casualty costs.