CP

Business Context and Reporting Period

Company: Canadian Pacific Railway Limited (CP)
Filing Type: Form 6-K (Report of Foreign Issuer)
Reporting Period: First Quarter ended March 31, 2009
Context: CP reported first-quarter results amidst a global economic downturn that caused a sharp decline in freight traffic volumes. The company fully consolidated the results of the Dakota, Minnesota & Eastern Railroad (DM&E) for the first time, whereas 2008 comparisons are presented on a pro forma basis to reflect this consolidation. Management highlighted successful variable expense reduction and balance sheet strengthening through equity issuance and asset sales.

Key Financial Metrics

Note: 2008 figures are restated on a pro forma basis to include DM&E line-by-line consolidation for comparability.

Material Changes vs. Prior Period

• Volume Decline: Total Revenue Ton-Miles (RTM) decreased 22.4% and total carloads dropped 18.6%. Significant declines were observed in Potash (-70%), Canadian Coal (-30%), and Automotive (-43%) sectors.
• Revenue Drivers: Freight revenues fell 12.6% due to lower volumes and reduced fuel recoveries. This was partially offset by solid pricing (Freight Revenue per RTM increased 12.5%) and a favorable impact from the weaker Canadian dollar on U.S. dollar-denominated revenues.
• Cost Management: Operating expenses decreased 7.7% due to lower volumes, reduced fuel prices, and cost-cutting measures. However, the operating ratio worsened from 82.4% to 87.0% as revenue declined faster than expenses.
• Workforce Reduction: The company executed over 2,400 employee layoffs in response to the temporary decline in traffic.
• Balance Sheet: Cash and cash equivalents surged to $566.5 million from $117.6 million at year-end 2008, driven by a $488.9 million net equity issuance and asset sales. Total debt increased to $4.98 billion, primarily due to the consolidation of DM&E debt.

Guidance, Outlook, and Risks

• Capital Program: CP reduced its 2009 capital program outlook to $720–$740 million, down from the original $800–$820 million and significantly lower than the $1.0 billion spent in 2008.
• Outlook: Management views the traffic decline as temporary, attributing it to the global recession. They expect the interest-coverage ratio (currently 3.6x, below the 4.0x target) to improve as volumes recover.
• Unusual Items:
  • ABCP Restructuring: In Q1 2009, CP completed a restructuring of Canadian Asset-Backed Commercial Paper (ABCP) investments, receiving replacement long-term floating rate notes. No fair value charge was recorded in Q1 2009, compared to a $21.3 million charge in Q1 2008.
  • Foreign Exchange: Net foreign exchange loss on long-term debt was $0.2 million in Q1 2009, a significant improvement from the $16.3 million loss in Q1 2008.
• Risks: Key risks include the duration of the global credit crisis, commodity price volatility, weather conditions affecting agricultural production, and potential labor disputes. The company also faces uncertainty regarding the valuation of long-term floating rate notes received in the ABCP restructuring.

Investor Verification Checklist

• Volume Recovery: Monitor subsequent quarterly reports for signs of stabilization or recovery in key commodity lines (Potash, Coal, Automotive) to validate the "temporary" nature of the decline.
• ABCP Valuation: Review future disclosures regarding the fair value of the replacement long-term floating rate notes from the ABCP restructuring, as sensitivity to discount rates and credit losses remains a risk.
• Interest Coverage: Track the interest-coverage ratio to ensure it returns to the management target of 4.0x as earnings recover.
• Capital Discipline: Verify adherence to the reduced 2009 capital program of $720–$740 million.
• Operating Ratio: Assess whether the operating ratio improves from 87.0% as volumes increase, given the fixed cost structure transformation efforts.