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, 2012 (Interim Results)
Date of Filing: July 25, 2012
Business Overview: CP operates a transcontinental railway in Canada and the United States, providing freight transportation, logistics, and supply chain services. The quarter was significantly impacted by a nine-day strike in Canada (May 23 – June 1, 2012) and a major management transition involving the appointment of E. Hunter Harrison as President and CEO.
Key Financial Metrics
| Metric (CAD Millions) | Q2 2012 | Q2 2011 | YTD 2012 | YTD 2011 |
|---|---|---|---|---|
| Total Revenues | $1,366 | $1,265 | $2,742 | $2,428 |
| Operating Income | $239 | $231 | $513 | $340 |
| Net Income | $103 | $128 | $245 | $162 |
| Diluted EPS | $0.60 | $0.75 | $1.42 | $0.95 |
| Operating Ratio | 82.5% | 81.7% | 81.3% | 86.0% |
| Cash from Operations | $326 | $213 | $527 | $348 |
| Capital Expenditures | ($292) | ($219) | ($525) | ($352) |
| Long-Term Debt | $4,745 | $4,695 | $4,745 | $4,695 |
| Cash & Equivalents | $82 | $268 | $82 | $268 |
Note: All figures are in Canadian dollars unless otherwise specified. YTD figures represent the six months ended June 30.
Material Changes vs. Prior Period
- Revenue Growth: Total revenues increased 8% in Q2 and 13% YTD compared to 2011. Growth was driven by higher volumes in Industrial/Consumer products and Automotive sectors, higher freight rates, and favorable foreign exchange impacts, partially offset by the strike.
- Profitability: While Operating Income increased 3% in Q2 and 51% YTD, Net Income decreased 20% in Q2 (due to significant one-time charges) but increased 51% YTD.
- Operating Ratio: The Q2 operating ratio worsened to 82.5% (up 80 basis points) primarily due to the strike and management transition costs. However, the YTD ratio improved significantly to 81.3% (down 470 basis points) due to operational efficiencies and volume growth.
- Strike Impact: The nine-day strike is estimated to have reduced diluted EPS by $0.25 to $0.30. It caused a loss of revenue but also resulted in cost savings in compensation, fuel, and equipment rents.
- Management Transition: Significant items, including management transition and advisory costs, negatively impacted Q2 diluted EPS by approximately $0.30. This included a $38 million charge for CEO transition costs.
- Tax Rate Change: An Ontario corporate income tax rate change resulted in an $11 million income tax expense in the quarter, increasing the effective tax rate to 31.8% for Q2.
Guidance, Outlook, and Risks
- Management Commentary: New CEO E. Hunter Harrison emphasized a focus on improving service offerings and driving long-term shareholder value, citing CP as a strong franchise with positive market opportunities.
- Capital Expenditures: CP expects 2012 capital programs to range between $1.1 billion and $1.2 billion. This includes $800 million for asset preservation, $275 million for strategic enhancements, and $50 million for regulatory requirements (Positive Train Control).
- Pension Outlook: Defined benefit pension contributions are estimated between $100 million and $125 million annually through 2016. Pension expense for 2012 is expected to be $41 million.
- Key Risks:
- Labor Relations: Collective agreements with key Canadian unions (TCRC) are subject to interest arbitration following the strike.
- Regulatory: Implementation of Positive Train Control (PTC) in the U.S. by 2015 is estimated to cost up to $280 million USD.
- Market Volatility: Exposure to fuel price fluctuations, foreign exchange rates (CAD/USD), and global economic conditions affecting bulk commodity demand (grain, coal, fertilizers).
Investor Verification Checklist
- Strike Resolution: Verify the status of the interest arbitration process with the Teamsters Canada Rail Conference and potential for future labor disruptions.
- Transition Costs: Confirm the full extent of one-time charges related to the CEO transition and the $20 million payment to Pershing Square Capital Management.
- Operational Metrics: Monitor "Car miles per car day" and "Average train speed" to assess the effectiveness of the new management's operational efficiency initiatives.
- Tax Rate Normalization: Review future effective tax rates to determine if the 31.8% Q2 rate is an anomaly or a new baseline due to Ontario legislation.
- Capital Spending: Track actual capital expenditures against the $1.1B–$1.2B guidance, specifically regarding PTC implementation costs.