CP

Business Context and Reporting Period

Company: Canadian Pacific Railway Limited (CP)
Filing Type: Form 6-K (Report of Foreign Issuer)
Reporting Period: Second Quarter ended June 30, 2015 (Interim)
Release Date: July 21, 2015

CP is a transcontinental railway operating in Canada and the United States. The company reported record quarterly net income and a record-low operating ratio for the second quarter, driven by cost control and efficiency improvements despite a sluggish North American economic recovery and lower commodity prices.

Key Financial Metrics

Material Changes vs. Prior Period

• Profitability Surge: Net income increased 12% in Q2 and 14% YTD. Operating income rose 10% in Q2 and 25% YTD, primarily due to lower fuel costs, efficiency gains, and favorable foreign exchange impacts.
• Revenue Stability: Total revenues were flat in Q2 (-2%) but grew 4% YTD. Freight revenues declined in Q2 due to lower volumes in Crude, Metals, and Grain, offset by higher rates and FX benefits.
• Cost Efficiency: The Operating Ratio improved by 420 basis points in Q2 to a record low of 60.9%. Fuel expenses dropped 32% in Q2 due to lower diesel prices and improved fuel efficiency.
• Shareholder Returns: The company repurchased 3.06 million shares in Q2 (5.23 million YTD) totaling $590 million in the quarter. Dividends remained stable at $0.35 per share.
• Debt Issuance: In Q1 2015, CP issued $700 million in 10-year notes, increasing long-term debt balances.

Guidance, Outlook, and Risks

Updated 2015 Full-Year Guidance

• Revenue Growth: 2-3%
• Operating Ratio: Below 62%
• Adjusted Diluted EPS: $10.00 to $10.40
• Capital Expenditures: Approximately $1.5 billion
• Key Assumptions: CAD/USD exchange rate of 1.25; Effective tax rate of 27.5% (excluding discrete items); Average On Highway Diesel price of $2.80-$2.90 USD.

Management Commentary

CEO E. Hunter Harrison emphasized CP's disciplined approach to cost control and efficiency to offset economic headwinds. The company highlighted its ability to remain nimble and efficient despite global economic softness and reduced commodity shipments.

Risks and Contingencies

• Regulatory Change: CP will no longer be exempt from regular SEC reporting requirements in 2016 due to a change in board composition (majority U.S. citizens/residents). It will file Form 10-K starting in 2016.
• Lac-Mégantic Litigation: CP is a defendant in class action lawsuits and administrative proceedings related to the 2013 Lac-Mégantic derailment. While CP denies liability, potential losses cannot be quantified at this stage. A $430 million settlement fund was approved for Montreal Maine and Atlantic Railway (MM&A) creditors, but CP has not contributed to this fund.
• Environmental Liabilities: Accruals for environmental remediation totaled $94 million as of June 30, 2015.
• Foreign Exchange: Significant volatility in FX translation on U.S. dollar-denominated debt impacted earnings, resulting in a $10 million gain in Q2 and a $64 million charge in Q1.

Investor Verification Checklist

• Adjusted EPS Reconciliation: Verify the reconciliation of Adjusted EPS ($2.45) to GAAP EPS ($2.36), specifically the impact of the $23 million Alberta tax rate change and FX translation gains.
• Debt Covenants: Confirm compliance with the amended revolving credit facility covenant (Debt to EBITDA ratio) following the Q1 debt issuance.
• Share Repurchase Progress: Monitor the remaining capacity under the Normal Course Issuer Bid (NCIB) to purchase up to 9.14 million shares.
• Lac-Mégantic Exposure: Track developments in the MM&A bankruptcy proceedings and potential Carmack Amendment claims against CP.
• SEC Reporting Transition: Review the upcoming shift to Form 10-K reporting requirements effective January 1, 2016.