Canadian Pacific Railway Limited — Q3 2017 Form 10-Q
Business context and reporting period. This unaudited quarterly filing is for the three and nine months ended September 30, 2017. The registrant is Canadian Pacific Railway Limited (CP); the filing is not under the name Canadian Pacific Kansas City Limited. Financial amounts are in Canadian dollars unless stated otherwise.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Revenue | $1,595 million | $1,554 million | $4,841 million | $4,595 million |
| Operating income | $690 million | $657 million | $2,040 million | $1,861 million |
| Net income | $510 million | $347 million | $1,421 million | $1,215 million |
| Diluted EPS | $3.50 | $2.34 | $9.70 | $8.02 |
| Adjusted diluted EPS (non-GAAP) | $2.90 | $2.73 | $8.17 | $7.26 |
| Operating ratio | 56.7% | 57.7% | 57.9% | 59.5% |
| Cash from operating activities | $527 million | $591 million | $1,449 million | $1,321 million |
| Free cash (non-GAAP) | $214 million | $315 million | $575 million | $488 million |
Q3 revenue grew 3%, operating income 5%, and net income 47% year over year. Reported diluted EPS rose 50%, but adjusted diluted EPS increased 6%; reported earnings benefited substantially from foreign-exchange gains on U.S.-dollar debt. For the first nine months, revenue rose 5%, operating income 10%, net income 17%, and adjusted diluted EPS 13%. Operating-ratio improvement reflected higher volumes, pension income and operational efficiencies.
Freight revenue growth reflected stronger volumes, notably in frac sand, potash and energy-related traffic. In Q3, Metals, Minerals and Consumer Products revenue increased 35% and Potash increased 27%; Automotive fell 21%, Grain fell 6%, and Intermodal fell 2%. Nine-month RTMs increased 5%.
Cash, debt and liquidity
- Cash and cash equivalents were $142 million at September 30, 2017, versus $164 million at December 31, 2016. Nine-month capital additions were $895 million; dividends paid were $229 million and share repurchases were $368 million.
- Long-term debt, including $749 million maturing within one year, totaled $8.133 billion, down from $8.684 billion at year-end 2016. The debt’s estimated fair value was approximately $9.587 billion. The $749 million current maturity compares with $25 million at year-end.
- The company reported an undrawn U.S.$2.0 billion revolving credit facility, no commercial paper borrowings, and $286 million available under its letters-of-credit arrangements. It reported compliance with its revolving-credit covenant.
- Adjusted net debt to adjusted EBITDA was 2.7x, compared with 3.0x a year earlier; management’s long-term target range is 2.0x–2.5x. Interest coverage was 6.1x, and adjusted interest coverage was 5.7x.
- Declared dividends were $0.5625 per share for Q3, up from $0.50. The company repurchased 1.8 million shares during the first nine months under its issuer bid.
Outlook, commentary and notable matters
- 2017 outlook: Management expected double-digit growth in full-year adjusted diluted EPS from 2016 adjusted diluted EPS of $10.29, assuming mid-single-digit RTM growth and an approximately 26.5% normalized tax rate. Planned 2017 capital investment was approximately $1.25 billion. This is forward-looking guidance and is not reconciled to GAAP diluted EPS in the filing.
- Drivers and operating indicators: Management cited strong year-to-date performance and a constructive volume outlook. Q3 average terminal dwell improved 6% to 6.6 hours, while average train speed declined 3% to 23.1 mph, partly reflecting a greater mix of heavier, slower traffic. Nine-month personal-injury and train-accident rates were higher than the comparable prior-year period.
- Unusual earnings items: Q3 included a $105 million foreign-exchange gain on U.S.-dollar debt. Nine-month results also included a $51 million management-transition recovery, a $10 million insurance recovery, a $13 million hedge-roll/de-designation charge, and a net $14 million deferred-tax recovery from tax-rate changes. In 2016, Q3 included a $25 million legal-settlement charge.
- Legal and environmental exposure: The Lac-Mégantic-related proceedings remained unresolved. Québec’s claim was $409 million; a motion sought to reduce it to $315 million. Other proceedings include a class action, insurer claims, and U.S. litigation. CP denied liability and said potential responsibility and losses could not yet be determined. Environmental remediation accruals were $79 million, with payments expected through 2026.
- Regulatory and other risks: Proposed Canadian Bill C-49 could change shipper remedies, rail-service regulation and safety requirements; the filing said enactment timing was unclear. Broader risks include regulation, fuel and currency movements, weather, operating disruptions, safety incidents, litigation, and pension funding volatility.
- Accounting developments: CP expected the new lease standard, effective in 2019, to materially increase recognized right-of-use assets and lease liabilities, with no material income-statement impact anticipated. It did not expect a material revenue-recognition change from adopting the customer-contract standard in 2018.
Important facts for investors to verify
- How much of reported earnings and EPS growth reflects recurring operating performance versus foreign-exchange gains and other excluded items.
- Whether the 2017 adjusted-EPS, volume, tax-rate and capital-spending outlook was achieved, and how comparable GAAP results differed.
- The timing and funding of near-term debt maturities, capital investment, dividends and repurchases, alongside free-cash generation and leverage.
- Developments, potential exposure and insurance or contribution recoveries in Lac-Mégantic-related litigation and environmental matters.
- Whether operating and safety trends, fuel costs, regulatory changes and pension assumptions materially affect future margins and cash requirements.
Adjusted EPS, adjusted income, free cash, adjusted leverage and related adjusted ratios are non-GAAP measures, are not standardized, and may not be comparable with similarly named measures used by other companies.