CP

Business Context and Reporting Period

Company: Canadian Pacific Railway Limited (CP)

Filing Type: Form 6-K (Report of Foreign Issuer)

Reporting Period: Third Quarter ended September 30, 2011 (Interim)

Business Overview: CP operates a transcontinental railway in Canada and the U.S., providing freight transportation, logistics, and supply chain expertise. The network spans approximately 14,700 miles, serving major business centers from Montreal to Vancouver and into the U.S. Northeast and Midwest.

Key Financial Metrics

Note: Q3 2010 operating cash flow was negatively impacted by a $650 million voluntary pension prepayment.

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 4.3% in Q3 2011 and 2.2% YTD, driven by higher freight rates, fuel cost recovery, and increased volumes in coal, sulphur/fertilizers, and industrial products. This offset declines in grain and intermodal traffic.
• Operating Expenses: Expenses rose 7.2% in Q3 and 8.2% YTD. The primary driver was a 47% increase in average fuel prices (to $3.44/gallon). Additional costs stemmed from inefficient operations due to severe weather and flooding, higher crew training, and IT system renewals.
• Profitability Decline: Operating income decreased 3.9% in Q3 and 18.8% YTD. Net income fell 5.3% in Q3 and 25.0% YTD. The decline was exacerbated by a $8.8 million loss on the early redemption of 2013 Notes and foreign exchange losses on working capital.
• Volume Trends: Total carloads decreased 2.5% in Q3 and 3.3% YTD, primarily due to lower intermodal and grain volumes. However, Revenue Ton-Miles (RTMs) increased 3.6% in Q3 and 1.5% YTD due to longer hauls in coal and potash.

Guidance, Outlook, and Risks

• Capital Expenditures: Updated 2011 capital spending guidance is approximately $1.1 billion (up from a previous range of $950M-$1.05B), reflecting additional locomotive purchases and infrastructure investments.
• Pension Contributions: Estimated at approximately $100 million for 2011, with a range of $125 million to $150 million for the subsequent three to four years.
• Management Commentary: CEO Fred Green noted strength in the bulk franchise but emphasized vigilance regarding economic signals from Asia. The company remains focused on service reliability and productivity investments.
• Key Risks:
  • Weather & Operations: Severe winter weather and prolonged flooding in the first half of 2011 disrupted operations and increased costs.
  • Fuel Volatility: Significant exposure to diesel price fluctuations, partially mitigated by fuel cost recovery programs and hedging.
  • Foreign Exchange: Fluctuations between the Canadian and U.S. dollar impact revenues and expenses, as a significant portion of the business is U.S.-denominated.
  • Regulatory: Ongoing legislative changes in Canada (Bill S-4) and U.S. (Positive Train Control implementation by 2015) may impact costs and operations.

Investor Verification Checklist

• Fuel Hedging Effectiveness: Verify the extent of residual fuel price exposure not covered by cost recovery programs and the performance of diesel futures contracts.
• Weather Impact Duration: Assess whether operational inefficiencies and costs related to flooding and winter weather are fully resolved or expected to persist into Q4.
• Intermodal Market Share: Monitor trends in intermodal volumes, which declined due to service disruptions and supply chain issues, to gauge recovery potential.
• Debt Redemption Costs: Confirm the impact of the $8.8 million loss on the 2013 Notes redemption and subsequent debt issuance (US$92M 3.88% Notes) on future interest expenses.
• Pension Funded Status: Review the sensitivity of pension funding requirements to changes in discount rates and asset returns, given the large defined benefit obligation.