CP

Business Context and Reporting Period

Company: Canadian Pacific Railway Limited (CP)
Filing Type: Form 6-K (Report of Foreign Issuer)
Reporting Period: Fourth Quarter and Full Year ended December 31, 2007
Filing Date: January 29, 2008

CP reported fourth-quarter and full-year 2007 results. The company faced operational challenges in December 2007 due to harsh weather conditions that disrupted the supply chain and restricted freight volumes. Despite these headwinds, the company delivered earnings growth driven by operating income improvements and foreign exchange gains on long-term debt.

Key Financial Metrics

Material Changes vs. Prior Period

• Net Income Growth: Full-year 2007 net income increased 19% to $946 million from $796 million in 2006. Q4 2007 net income surged to $342 million from $146 million in Q4 2006.
• Revenue Trends: Full-year revenue grew 3% to $4.7 billion. Q4 revenue was flat at $1.19 billion. Freight revenue excluding foreign exchange grew 5% in Q4, but the stronger Canadian dollar resulted in a 1% reported decline in freight revenue for the quarter.
• Expense Pressures: Operating expenses increased 3% for the full year to $3.5 billion, driven primarily by a 14.8% increase in fuel costs. Q4 operating expenses rose 1% to $883 million.
• Foreign Exchange Impact: CP recorded a significant foreign exchange gain on long-term debt of $170 million for the full year 2007, compared to a negligible loss in 2006. In Q4, the gain was $8 million versus a $45 million loss in Q4 2006.
• Tax Benefits: The company recorded a $163 million future tax benefit in 2007 due to lower Canadian income tax rates, compared to $176 million in 2006.

Guidance, Outlook, and Risks

2008 Outlook

• Earnings: Diluted EPS (excluding FX gains/losses on debt and specified items) is expected to range between $4.70 and $4.85.
• Revenue & Expenses: Total revenue is projected to grow 4-6%, while operating expenses are expected to increase 3-5%.
• Capital Investment: Expected to be flat at $885-$895 million.
• Free Cash Flow: Expected to exceed $250 million.
• Assumptions: Outlook assumes a US/Canadian dollar exchange rate at par and crude oil prices averaging $87 per barrel (up from a previous assumption of $80).

Risks and Contingencies

• ABCP Investment: CP holds $144 million in Asset-Backed Commercial Paper (ABCP) that did not settle on maturity due to market liquidity issues. A $21 million charge was taken in Q3 2007. The fair value is estimated at $122.1 million as of Dec 31, 2007. A restructuring is anticipated in March 2008, but uncertainties regarding asset values and cash flows remain.
• DM&E Acquisition: CP acquired Dakota, Minnesota & Eastern Railroad (DM&E) for approximately $1.5 billion in October 2007. The transaction is subject to U.S. Surface Transportation Board approval, expected in 2008. Future contingent payments of up to $1.05 billion may be required based on milestones.
• Operational Risks: Management cited severe weather in December 2007 as a significant disruptor. Future risks include fuel price volatility, labor disputes, and regulatory changes.

Investor Verification Checklist

• ABCP Restructuring Outcome: Verify the final terms of the ABCP restructuring in March 2008 and any potential additional impairment charges.
• DM&E Regulatory Approval: Monitor the U.S. Surface Transportation Board's final ruling on the DM&E acquisition and the timeline for full consolidation.
• Fuel Cost Pass-Through: Assess the effectiveness of fuel recovery programs in offsetting rising energy costs in 2008.
• Currency Sensitivity: Evaluate the impact of the stronger Canadian dollar on reported revenues versus underlying volume growth.
• Capital Commitments: Review the $504 million in multi-year capital commitments and $614.9 million in operating lease obligations.