Business Context and Reporting Period
Company: Canadian Pacific Railway Limited (CP)
Filing Type: Form 6-K (Report of Foreign Issuer)
Reporting Period: Second Quarter and First Half ended June 30, 2009
Business Overview: CP operates a transcontinental railway in Canada and the United States, transporting bulk commodities (grain, coal, sulphur, fertilizers), merchandise freight, and intermodal traffic. The company is currently navigating a global recession which has significantly impacted freight volumes, though management notes volumes appear to have stabilized without a sustained recovery.
Key Financial Metrics
| Metric | Q2 2009 | Q2 2008 | YTD 2009 | YTD 2008 |
|---|---|---|---|---|
| Total Revenues | $1,022.4 million | $1,220.3 million | $2,093.1 million | $2,367.2 million |
| Net Income | $157.3 million | $154.7 million | $219.8 million | $245.4 million |
| Diluted EPS | $0.93 | $1.00 | $1.33 | $1.58 |
| Operating Expenses | $796.6 million | $969.4 million | $1,727.9 million | $1,918.3 million |
| Operating Ratio | 77.9% | 79.4% | 82.6% | 81.0% |
| Cash & Equivalents | $334.3 million | $80.9 million | $334.3 million | $80.9 million |
| Total Debt | $4,420.0 million | $4,510.2 million | $4,420.0 million | $4,510.2 million |
Note: Debt figures represent Total Debt (Long-term + Current portion + Short-term borrowing) as of June 30, 2009.
Material Changes vs. Prior Period
- Revenue Decline: Total revenues decreased 16.2% in Q2 and 11.6% YTD compared to 2008. On a pro forma basis (consolidating DM&E results for comparability), freight revenues dropped 23.7% in Q2 and 18.3% YTD, driven by the global recession and reduced demand across most commodity lines except grain.
- Net Income Stability: Despite lower operating income, Q2 net income increased 1.7% to $157.3 million. This was primarily due to a one-time after-tax gain of $68.7 million from the sale of a portion of CP's interest in the Detroit River Tunnel Partnership (DRTP). YTD net income decreased 10.4% to $219.8 million.
- Operating Ratio: The operating ratio improved to 77.9% in Q2 (down from 79.4% in 2008) due to cost management and lower fuel prices, partially offset by volume declines. However, the YTD ratio deteriorated to 82.6% (up from 81.0% in 2008) due to the significant drop in volumes.
- Fuel Costs: Fuel expenses decreased significantly (57.4% in Q2, 44.5% YTD on a pro forma basis) due to lower fuel prices and reduced volumes.
- Capital Program: The 2009 capital program outlook was revised upward to $800–$820 million (from a previous $720–$740 million) due to the buy-out of operating leases.
Guidance, Outlook, and Risks
- Management Commentary: CEO Fred Green stated that while freight volumes appear to have stabilized, a sustained recovery has not yet occurred. Management is focused on cost management and strengthening the balance sheet.
- Capital Expenditures: CP expects 2009 capital spending to range between $800 million and $820 million. The increase is attributed to buying out operating leases, with cash impact expected to be offset by equipment sales in the latter half of 2009.
- Unusual Items:
- DRTP Sale: A $68.7 million after-tax gain was recognized in Q2 2009 from selling part of the DRTP interest.
- ABCP Restructuring: CP recorded a $3.2 million after-tax gain in Q2 2009 related to the fair value of long-term floating rate notes received in replacement of Asset-Backed Commercial Paper (ABCP).
- Debt Repurchase: CP repurchased debt with a carrying amount of $555.3 million for $571.9 million, recognizing a net loss of $16.6 million.
- Risks and Contingencies:
- Economic Conditions: Continued uncertainty regarding the timing of the global economic recovery.
- Regulatory: Adverse rate outcomes from arbitration with major customer Teck Coal Limited regarding coal transportation rates.
- Pension Funding: Significant volatility in pension funding requirements due to market declines and interest rate changes. 2009 contributions are estimated at $100–$150 million, with 2010 estimates ranging from $250–$300 million depending on market performance.
- Labour Relations: Approximately 75% of the workforce is unionized; several collective agreements are under renegotiation.
Investor Verification Checklist
- Non-GAAP Adjustments: Verify the impact of the $68.7 million DRTP gain and ABCP fair value adjustments on reported net income versus underlying operating performance.
- Pro Forma Comparisons: Review pro forma data which consolidates Dakota, Minnesota & Eastern Railroad (DM&E) results for 2008 to ensure accurate year-over-year trend analysis.
- Foreign Exchange Impact: Assess the sensitivity of earnings to the Canadian/US dollar exchange rate, which weakened significantly in 2009, providing a favorable translation impact on US-denominated revenues but unfavorable impact on expenses.
- Capital Commitments: Confirm the $785.5 million in multi-year capital commitments and the revised 2009 capital spending outlook.
- Debt Covenants: Monitor the Total Debt to Total Capitalization ratio (40.1% at June 30, 2009) and Interest Coverage Ratio (3.4x), noting the latter is currently below the management target of 4.0x due to recessionary earnings.