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, 2008
Filing Date: April 22, 2008

CP operates a transcontinental railway in Canada and the United States, transporting bulk commodities, merchandise freight, and intermodal traffic. The quarter was characterized by severe winter weather conditions affecting the central and eastern network, significant increases in fuel prices, and a strengthening Canadian dollar.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 3% to $1.15 billion. Freight revenues rose 10% organically, driven by strong demand for bulk products (grain, coal, sulphur/fertilizers) and industrial/consumer products. However, the strengthening Canadian dollar reduced reported growth to 3%.
• Operating Expenses: Expenses increased 7% to $948.7 million. The primary drivers were a 34.5% increase in fuel costs (due to higher WTI prices and refining margins) and less efficient operations caused by severe winter weather.
• Profitability Decline: Net income dropped 29% to $91 million. This was driven by lower operating income, a $16.3 million foreign exchange loss on long-term debt, and a $21.3 million charge related to the fair value adjustment of Asset-Backed Commercial Paper (ABCP) investments.
• Volume Trends: Total carloads increased 2.2%. Grain, coal, and intermodal volumes grew, while forest products and automotive volumes declined due to a weaker US economy and housing market slowdown.

Guidance, Outlook, and Risks

2008 Guidance Update

Management revised its full-year 2008 outlook downward due to harsh weather, rising fuel costs, and economic uncertainty:

• Adjusted Diluted EPS: Revised to $4.40 – $4.60 (previously $4.65 – $4.80).
• Total Revenues: Expected to grow 4% – 6% (unchanged).
• Operating Expenses: Expected to increase 6% – 8% (previously 3% – 5%).
• Free Cash Flow: Revised to approximately $200 million (previously >$250 million).
• Key Assumptions: WTI crude oil at $98/barrel; All-in fuel cost at $3.35/gallon; Average FX rate at par (1.00 CAD/USD).

Material Risks and Contingencies

• ABCP Investment: CP holds $143.6 million in Canadian third-party ABCP. A further $21.3 million charge was taken in Q1 2008, bringing the total write-down to ~30% of original value. The restructuring process is ongoing, and further material changes in value are possible.
• DM&E Acquisition: CP acquired Dakota, Minnesota & Eastern Railroad (DM&E) in October 2007 for ~$1.5 billion. The transaction is pending US Surface Transportation Board approval. Future contingent payments of up to $1.05 billion may be required based on milestones.
• Regulatory: The Canadian Transportation Agency directed a downward adjustment to the grain revenue cap. CP has appealed the retroactive component (~$23 million), which has not been accrued.
• Liquidity: Net debt increased significantly due to bridge financing for the DM&E acquisition. Credit ratings remain investment grade (Baa3/BBB), though S&P has a negative outlook.

Investor Verification Checklist

• ABCP Restructuring Outcome: Monitor the April 25, 2008 vote on the ABCP restructuring plan and subsequent valuation impacts on earnings.
• DM&E Regulatory Approval: Track the US Surface Transportation Board's final ruling on the DM&E acquisition to confirm consolidation timing and potential contingent payments.
• Fuel Cost Pass-Through: Verify the effectiveness of fuel recovery programs in offsetting the projected $98/barrel WTI price assumption.
• Grain Revenue Cap Appeal: Review the status of the appeal regarding the Canadian Transportation Agency's grain revenue cap adjustment.
• Weather Impact: Assess whether Q1 weather-related inefficiencies are recurring or isolated, as this impacts the operating ratio outlook.