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, 2008 (Interim)
Release Date: July 22, 2008
CP operates a transcontinental railway in Canada and the United States. The second quarter was characterized by a "tough" operating environment due to unprecedented fuel price increases, a North American economic downturn, and prolonged flooding on the US mainline. Management is implementing rigorous productivity and efficiency measures to position the company for 2009.
Key Financial Metrics
| Metric | Q2 2008 | Q2 2007 | YTD 2008 | YTD 2007 |
|---|---|---|---|---|
| Total Revenues | $1,220.3 million | $1,215.5 million | $2,367.2 million | $2,331.4 million |
| Net Income | $154.9 million | $256.7 million | $245.7 million | $385.3 million |
| Diluted EPS | $1.00 | $1.64 | $1.59 | $2.46 |
| Adjusted Diluted EPS (Excl. FX on LTD & Specified Items) |
$0.97 | $1.12 | $1.72 | $1.90 |
| Operating Ratio | 79.4% | 74.7% | 81.0% | 77.0% |
| Operating Expenses | $969.2 million | $907.8 million | $1,917.9 million | $1,794.4 million |
| Cash Provided by Operating Activities | $183.0 million | $364.5 million | $343.0 million | $592.2 million |
| Free Cash (Non-GAAP) |
($30.2) million | $159.6 million | ($169.3) million | $162.6 million |
| Long-Term Debt | $4,016.8 million | $4,146.2 million | $4,016.8 million | $4,146.2 million |
| Cash and Cash Equivalents | $80.9 million | $378.1 million | $80.9 million | $378.1 million |
Material Changes vs. Prior Period
- Revenue: Total revenues were essentially flat in Q2 2008 ($1.22 billion) compared to Q2 2007. Freight revenues increased 1.6% despite a decrease in traffic volume, driven primarily by pricing and fuel recoveries.
- Profitability: Net income decreased 40% in Q2 2008 to $155 million. Adjusted diluted EPS fell 13.4% to $0.97. The decline is attributed to higher fuel costs, lower FX gains on long-term debt, and a one-time tax benefit in 2007.
- Operating Expenses: Expenses increased 6.8% in Q2 2008. Fuel expenses surged 34.4% due to higher West Texas Intermediate (WTI) prices. This was partially offset by a 19.5% decrease in equipment rents and a 4.3% decrease in compensation and benefits.
- Operating Ratio: Deteriorated to 79.4% in Q2 2008 from 74.7% in Q2 2007, primarily due to the significant rise in fuel costs.
- Commodity Mix:
- Increases: Industrial and consumer products (+17%), Intermodal (+9%), and Coal (+6%).
- Decreases: Forest products (-21%), Grain (-9%), and Automotive (-2%).
Guidance, Outlook, and Risks
2008 Guidance Update (July 2008)
Management revised its full-year 2008 outlook to reflect higher fuel assumptions and deteriorating economic conditions:
- Adjusted Diluted EPS: Revised down to $4.00 - $4.20 (Previous: $4.40 - $4.60).
- Total Revenues: Expected to grow 6% - 8% (Previous: 4% - 6%), driven by fuel recovery.
- Operating Expenses: Expected to increase 11% - 13% (Previous: 6% - 8%) due to higher fuel costs.
- Free Cash: Revised down to approximately $150 million (Previous: ~$200 million).
- Key Assumptions: Crude oil averaging US $121/barrel (vs. $98 previously); All-in fuel price US $3.80 - $3.90/gallon; Normalized tax rate 26% - 27%.
Risks and Contingencies
- ABCP Investment: CP holds Canadian third-party Asset-Backed Commercial Paper (ABCP) with an original cost of ~$144 million. The estimated fair value at June 30, 2008, was $100.8 million. A $21.3 million charge was taken in Q1 2008. Continued uncertainty regarding the restructuring process could lead to further material changes in value.
- Regulatory: The Canadian Transportation Agency directed a downward adjustment of the maximum revenue entitlement for regulated grain. CP has appealed this decision; a provision has been made for the prospective adjustment, but the retroactive component (~$23 million) is not considered legally supportable.
- Acquisition: The acquisition of Dakota, Minnesota & Eastern Railroad (DM&E) is subject to US Surface Transportation Board approval. Future contingent payments of up to US $1.05 billion may be payable based on milestones.
- Labour Relations: Negotiations are ongoing with several US bargaining units. Work stoppages could materially impact operations.
Investor Verification Checklist
- Fuel Sensitivity: Verify the impact of WTI price fluctuations on future earnings. A $2/barrel change in WTI impacts EPS by $0.01.
- ABCP Valuation: Monitor the restructuring process of the ABCP investment, as further write-downs could impact near-term earnings.
- DM&E Approval: Track the status of the US Surface Transportation Board approval for the DM&E acquisition, which affects consolidation and contingent payments.
- Grain Revenue Cap: Follow the outcome of the appeal regarding the Canadian Transportation Agency's decision on the grain revenue cap.
- Free Cash Flow: Note the shift to negative free cash flow in the first half of 2008 due to capital expenditures and the termination of the accounts receivable securitization program.