Canadian Pacific Railway Limited — Q1 2016 Form 10-Q
Period: Three months ended March 31, 2016; comparisons are with Q1 2015 unless noted. Financial amounts are in Canadian dollars. The filing registrant is Canadian Pacific Railway Limited.
Business context and results
CP operates a freight railway. Revenue and traffic were pressured by lower fuel surcharges and weaker volumes in several markets, while management cited operational efficiency and improved asset utilization as important contributors to profitability.
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Total revenue | $1,591 million | $1,665 million | Down 4% |
| Operating income | $653 million | $612 million | Up 7% |
| Operating ratio | 58.9% | 63.2% | Improved 430 bps |
| Net income | $540 million | $320 million | Up 69% |
| Diluted EPS | $3.51 | $1.92 | Up 83% |
| Adjusted diluted EPS (non-GAAP) | $2.50 | $2.26 | Up 11% |
| Cash from operations | $218 million | $555 million | Down $337 million |
| Free cash (non-GAAP) | $(71) million | $312 million | Down $383 million |
Financial position and cash flow
- At March 31, cash and equivalents were $571 million, versus $650 million at year-end 2015. Total assets were $19.349 billion and shareholders’ equity was $5.290 billion.
- Long-term debt was $8.430 billion, with $23 million maturing within one year; total debt carrying value was $8.453 billion. The filing estimates debt fair value at approximately $9.491 billion.
- Operating cash flow fell mainly because of an unfavorable working-capital movement, including higher taxes paid, and higher interest payments. Property additions were $278 million; investing cash outflow was $218 million.
- The company reported an undrawn US$2 billion revolving credit facility and $371 million of letters of credit drawn under facilities with $600 million total availability. Management said liquidity was adequate and the company complied with its revolving-facility debt covenant.
- Adjusted net debt to adjusted EBITDA was 2.6x, versus 2.3x a year earlier. Interest coverage was 6.1x, versus 8.2x.
Material changes and drivers
- Freight revenue declined 5%, mainly due to an $82 million reduction in fuel-surcharge revenue and lower traffic; a favorable $107 million foreign-exchange effect partly offset the decline. Non-freight revenue rose to $43 million from $35 million.
- Revenue ton-miles and freight gross ton-miles each fell 5%. Crude, U.S. grain, coal, potash, metals/minerals/consumer products, and domestic intermodal were among the weaker lines; Canadian grain, forest products, chemicals and plastics, and automotive were stronger.
- Operating expenses decreased 11% to $938 million, reflecting lower fuel costs, efficiency gains, lower workload-related costs, higher pension income, and lower casualty and stock-based compensation expense. Wage and benefit inflation of about 3% and currency effects partly offset savings.
- Reported earnings included a non-cash $181 million foreign-exchange gain on U.S.-dollar debt ($156 million after tax). Excluding this significant item, adjusted income was $384 million, compared with $375 million. Net interest expense increased to $124 million from $85 million, in part due to debt issued in 2015.
- Operating indicators improved: average train speed rose 21% to 23.5 mph, terminal dwell declined 22% to 6.9 hours, and fuel efficiency improved 5%. Average workforce declined 13% to 12,434.
Outlook, management commentary, risks and unusual items
- CP expected to invest approximately $1.1 billion in 2016 capital programs, primarily track and roadway, funded by operating cash flow and financing sources. It estimated 2016 pension contributions of $80–$90 million and an annualized normalized tax rate of approximately 27.25%.
- After quarter-end, CP announced a proposed normal-course share repurchase of up to 6.91 million shares, subject to exchange acceptance, and raised its quarterly dividend from $0.35 to $0.50 per share. The next $0.50 dividend was declared April 19 for payment July 25, 2016.
- The most significant disclosed contingency is litigation related to the 2013 Lac-Mégantic derailment. Quebec claimed $409 million; related class, bankruptcy-trustee, cargo, and other proceedings remain. CP denies liability, and the company said potential liability and loss could not be determined at this stage. Management did not expect resolution of ordinary-course legal matters to materially harm financial position or results.
- CN sued CP and certain personnel over alleged use of confidential customer data; CN had not substantiated its damages claim, and any loss was not reasonably estimable. Environmental remediation accruals were $88 million, with payments expected through 2026.
- Management identified exposure to economic and traffic conditions, fuel and currency fluctuations, weather and agricultural risks, labor, safety and derailment liabilities, pension funding volatility, regulation, and litigation. Management stated interim results are not necessarily indicative of full-year results.
- The Arbutus Corridor sale generated $55 million gross proceeds and a $50 million pre-tax gain; CP may share in future proceeds from certain parcels. The 2015 comparison included a $31 million gain on settlement and sale of a building.
Important facts for investors to verify
- Whether operating efficiency can offset weak traffic and the unusually material impact of fuel surcharges and foreign exchange.
- Underlying earnings and cash generation apart from the $181 million non-cash FX gain; note adjusted measures are non-GAAP.
- Working-capital normalization, free cash flow, planned $1.1 billion capital spending, and debt-service trends.
- Developments and potential exposure in the Lac-Mégantic and CN legal proceedings, for which loss estimates are not clear or reasonably determinable.
- Execution of the proposed share repurchase and higher dividend, alongside leverage, pension funding, and liquidity requirements.