Canadian Pacific Railway Limited — Q3 2021 Form 10-Q
Reporting period: Three and nine months ended September 30, 2021; amounts are Canadian dollars unless stated otherwise. The filing is by Canadian Pacific Railway Limited, notwithstanding the request metadata naming Canadian Pacific Kansas City Ltd.
Business context and reporting period
CP is a freight railway operator. Results reflect a mixed recovery in freight demand, drought-related weakness in grain, British Columbia wildfire disruption, higher fuel prices, and costs related to the pending Kansas City Southern (KCS) acquisition. Comparative per-share data reflect the five-for-one share split completed in May 2021.
Financial performance
| Metric | Q3 2021 | Q3 2020 | Nine months 2021 | Nine months 2020 |
|---|---|---|---|---|
| Revenue | $1,942 million | $1,863 million | $5,955 million | $5,698 million |
| Operating income | $774 million | $779 million | $2,374 million | $2,383 million |
| Net income | $472 million | $598 million | $2,320 million | $1,642 million |
| Diluted EPS | $0.70 | $0.88 | $3.46 | $2.41 |
| Adjusted diluted EPS (non-GAAP) | $0.88 | $0.82 | $2.81 | $2.52 |
| Operating ratio | 60.2% | 58.2% | 60.1% | 58.2% |
| Adjusted operating ratio (non-GAAP) | 59.4% | 58.2% | 57.7% | 58.2% |
| Cash from operating activities | $548 million | $493 million | $3,084 million | $1,817 million |
| Capital additions | $372 million | $484 million | $1,111 million | $1,341 million |
Q3 revenue increased 4%, as higher freight yield more than offset lower freight volumes: revenue ton-miles fell 4%, while freight revenue per ton-mile rose 8%. Higher fuel prices lifted both surcharge revenue and costs. Net income and reported EPS declined principally because of KCS acquisition-related expenses and a $46 million foreign-exchange loss on debt and lease liabilities, versus a $40 million gain a year earlier. Adjusted Q3 diluted EPS rose 7%.
For the first nine months, reported net income included an $845 million KCS merger termination fee received in May. Acquisition-related costs were $442 million for the period. The fee and other significant items materially affect comparison with 2020; adjusted results exclude specified items and are non-GAAP measures.
Financial position, liquidity and debt
- At September 30, 2021, cash and cash equivalents were $210 million, restricted cash was $13 million, and total assets were $26.445 billion.
- Total debt, including current maturities, was $9.968 billion, versus $9.771 billion at December 31, 2020. Debt and finance-lease liabilities had a reported fair value of $10.533 billion.
- Shareholders’ equity was $9.468 billion, up from $7.319 billion at year-end 2020. The increase included nine-month net income and other comprehensive income, partly offset by dividends.
- The $1.3 billion revolving credit facility was undrawn. CP had $565 million of U.S.-dollar commercial paper outstanding and had fully drawn a $500 million U.S.-dollar term facility. A new U.S.-dollar $8.5 billion bridge facility was committed for the pending KCS transaction.
- Nine-month free cash, a company-defined non-GAAP measure, was $1.245 billion. Cash used in investing included the $1.773 billion payment to KCS; free cash excludes that payment and certain other specified items.
- Moody’s downgraded CP to Baa2 from Baa1 during Q1, citing the proposed KCS transaction; the outlook was stable. S&P’s BBB+ long-term corporate rating and stable outlook were unchanged.
Material changes and operating trends
- Freight revenue rose 4% in both Q3 and the first nine months. Q3 growth was strongest in energy, chemicals and plastics; metals, minerals and consumer products; and intermodal. Grain revenue fell 23% in Q3, principally due to drought-related lower Canadian grain volumes.
- Nine-month operating expenses increased 8%, including higher fuel costs, KCS transaction expenses, depreciation, inflation and pension service costs. Q3 operating ratio worsened by 200 basis points; nine-month adjusted operating ratio improved by 50 basis points.
- Q3 train weight rose 1% and train length 3%, while terminal dwell worsened 7% and train speed fell 4%, with wildfires cited as a factor. Q3 personal injury frequency improved to 0.97 from 1.03; train accident frequency worsened to 1.54 from 1.13 per million train-miles.
- CP paid no shares under its 2021 repurchase bid through September 30, citing the pending acquisition. Dividends declared were $0.190 per share in Q3 and $0.570 per share for the nine-month period.
Outlook, transaction and risks
CP revised its 2021 outlook to low-single-digit year-over-year growth in revenue ton-miles, citing weaker expectations for the 2021–2022 Canadian grain crop and continuing supply-chain challenges. It maintained guidance for double-digit growth in adjusted diluted EPS from 2020’s $3.53, with approximately $1.55 billion of capital expenditure and an approximately 24.6% effective tax rate. Management cautioned that forward-looking adjusted EPS cannot be reconciled to GAAP without unreasonable effort.
Under the September 2021 KCS merger agreement, KCS common shareholders are to receive 2.884 CP shares and U.S. $90 cash per share; KCS preferred shareholders are to receive U.S. $37.50 cash per share. The transaction was valued at approximately U.S. $31 billion enterprise value, including assumed KCS debt. CP expected a voting-trust closing in Q1 2022 and final control approval and combination in the second half of 2022; completion remained subject to shareholder, Mexican regulatory and other approvals. CP expected to issue approximately 262 million shares and incur about U.S. $12.3 billion of additional debt relative to September 2021 balances. The filing describes potential termination fees, including a U.S. $1 billion CP fee in specified regulatory-termination circumstances.
Other notable exposures include ongoing Lac-Mégantic litigation. A consolidated Quebec trial on liability began in September 2021; CP denies liability, and management said potential responsibility and losses could not yet be determined. Environmental remediation provisions were $82 million, with payments expected through 2030. The filing also identifies risks from transaction execution and financing, integration, COVID-19 and supply-chain effects, fuel and foreign-exchange volatility, severe weather, and regulatory and operating matters. Management considered ordinary-course legal provisions adequate and did not expect their resolution to materially adversely affect the company, while noting that the Lac-Mégantic outcome remained uncertain.
Investor verification priorities
- Track KCS shareholder and regulatory approvals, voting-trust timing, final STB review, transaction financing, expected share issuance and termination-fee exposure.
- Separate recurring operating performance from the $845 million termination payment, $442 million of acquisition costs, and foreign-exchange effects; assess the assumptions behind non-GAAP adjustments and guidance.
- Monitor grain volumes, wildfire and network impacts, fuel surcharge recovery timing, fuel costs, and service and safety indicators.
- Review debt ratings, leverage and liquidity as acquisition financing progresses, including the expected temporary increase in adjusted net debt to adjusted EBITDA to about 3.9.
- Follow Lac-Mégantic proceedings and environmental remediation estimates; the filing does not provide a clear estimate of potential losses from the unresolved litigation.