Business Context and Reporting Period
Company: Canadian Pacific Railway Limited (CP)
Filing Type: Form 6-K (Report of Foreign Issuer)
Reporting Period: Third Quarter and Nine Months Ended September 30, 2007
Business Overview: CP is a Class I railroad operating in Canada and the United States. The company reported strong third-quarter results driven by record volumes, despite headwinds from a strengthening Canadian dollar and rising fuel costs. A significant subsequent event was the acquisition of Dakota, Minnesota & Eastern Railroad (DM&E) on October 4, 2007, for approximately US$1.5 billion.
Key Financial Metrics
| Metric (in millions, except per share) | Q3 2007 | Q3 2006 (Restated) | YTD 9M 2007 | YTD 9M 2006 (Restated) |
|---|---|---|---|---|
| Total Revenues | $1,187.9 | $1,151.3 | $3,519.3 | $3,392.8 |
| Freight Revenues | $1,147.6 | $1,122.2 | $3,412.6 | $3,275.8 |
| Operating Expenses | $866.2 | $852.2 | $2,660.6 | $2,584.3 |
| Operating Income | $321.7 | $299.1 | $858.7 | $808.5 |
| Net Income | $218.6 | $163.8 | $603.9 | $650.7 |
| Diluted EPS | $1.41 | $1.04 | $3.87 | $4.09 |
| Adjusted Diluted EPS* | $1.23 | $1.07 | $3.13 | $2.79 |
| Operating Ratio | 72.9% | 74.0% | 75.6% | 76.2% |
| Cash & Equivalents (Sep 30, 2007) | $339.2 | |||
| Long-Term Debt (Sep 30, 2007) | $2,896.4 |
*Adjusted Diluted EPS excludes foreign exchange gains/losses on long-term debt and other specified items.
Material Changes vs. Prior Period
- Revenue Growth: Total revenues increased 3% in Q3 and 3.7% year-to-date (YTD). Freight revenues grew 2% in Q3 and 4% YTD.
- Commodity Mix: Coal (+7%) and Intermodal (+7%) revenues drove Q3 growth. Grain revenue increased 6%. These were partially offset by a 21% decline in Forest products and a 4% decline in Sulphur and fertilizers.
- Profitability: Net income rose 34% in Q3 to $219 million. However, YTD net income decreased 7% to $604 million, primarily due to a $176 million reduction in future income tax expense recognized in 2006 (not present in 2007) and a $21 million charge related to asset-backed commercial paper (ABCP).
- Adjusted Performance: Excluding FX and specified items, income increased 12% in Q3 and 9% YTD.
- Operating Efficiency: The operating ratio improved to 72.9% in Q3 (from 74.0%) and 75.6% YTD (from 76.2%).
- Cost Drivers: Operating expenses rose less than 2% in Q3 despite a 15% increase in fuel costs and a 12% increase in equipment rents. Compensation costs decreased 6% due to lower incentives and a post-retirement benefit settlement gain.
- Volume: Gross ton-miles (GTMs) increased 5% in Q3 and 5.7% YTD.
Guidance, Outlook, and Risks
- 2007 Outlook Revision: Management lowered expectations for full-year 2007 adjusted diluted EPS to the lower end of the growth target range ($4.30 to $4.45, or 9-13% growth). Revenue growth is expected to be just below the 4-6% target due to the strengthening Canadian dollar.
- Assumptions: Outlook assumes oil prices averaging US$69/barrel and an average exchange rate of $1.08 CAD/USD.
- Liquidity: Free cash flow is expected to exceed $300 million for 2007.
- ABCP Contingency: CP holds $144 million in Canadian third-party asset-backed commercial paper (ABCP) that did not settle at maturity due to market liquidity issues. A $21 million fair value charge was taken in Q3. Further changes in value are possible depending on the restructuring outcome.
- DM&E Acquisition: The acquisition of DM&E (US$1.5 billion) is subject to U.S. Surface Transportation Board approval. Future contingent payments of up to US$1.05 billion may be required based on track expansion and traffic milestones. The deal was financed with cash and a new US$1.8 billion credit facility.
- Risks: Key risks include currency fluctuations, fuel price volatility, weather conditions, and the outcome of the ABCP restructuring.
Investor Verification Checklist
- ABCP Exposure: Verify the status of the $144 million ABCP investment and potential for further impairment charges beyond the $21 million already recorded.
- DM&E Integration: Monitor the U.S. Surface Transportation Board approval timeline and the impact of the US$1.5 billion acquisition on future leverage and cash flow.
- Currency Impact: Assess the sensitivity of future revenue and earnings to the strengthening Canadian dollar, which management cites as a headwind.
- Fuel Hedging: Review the effectiveness of fuel hedging strategies given the 15% increase in fuel expenses in Q3.
- Restated Comparables: Ensure comparisons with 2006 data account for the restatement of stock-based compensation expenses (EIC 162 adoption).