Canadian Pacific Railway Limited — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016. Amounts are Canadian dollars unless stated otherwise. The filing names Canadian Pacific Railway Limited as registrant.
Business context and results
CP is a freight railway. Results reflected weaker freight volumes, notably in crude and Canadian grain, and lower fuel-surcharge revenue. Management cited improved operating efficiency and asset utilization as partial offsets.
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $1,554m | $1,709m | $4,595m | $5,025m |
| Operating income | $657m | $753m | $1,861m | $2,011m |
| Net income | $347m | $323m | $1,215m | $1,033m |
| Diluted EPS | $2.34 | $2.04 | $8.02 | $6.32 |
| Adjusted diluted EPS (non-GAAP) | $2.73 | $2.69 | $7.26 | $7.39 |
| Operating ratio | 57.7% | 55.9% | 59.5% | 60.0% |
| Adjusted operating ratio (non-GAAP) | 57.7% | 59.9% | 59.5% | 61.3% |
Cash flow, debt and liquidity
- Q3 operating cash flow was $591m, down from $696m; nine-month operating cash flow was $1,321m, down from $1,836m. Nine-month free cash, a company-defined non-GAAP measure, was $306m versus $979m.
- Property additions were $902m for the nine months, compared with $1,067m. Dividends paid were $182m; the declared quarterly dividend was raised to $0.50 per share from $0.35.
- At September 30, cash was $103m. Balance-sheet debt was $8,879m, including $391m maturing within one year. Commercial paper outstanding was US$280m; the US$2.0bn revolving facility was undrawn, with US$1.7bn available after commercial paper borrowings.
- Adjusted net debt to adjusted EBITDA was 3.0x, up from 2.7x a year earlier. Interest coverage was 5.4x versus 7.2x. CP reported compliance with its revolving-facility financial covenant.
Changes versus comparable periods
- Q3 revenue fell 9% and operating income fell 13%; the prior-year period included a $68m gain on the sale of Delaware & Hudson South. Excluding that gain, adjusted operating ratio improved by 220 basis points, to 57.7% from 59.9%.
- Q3 net income rose 7% and diluted EPS rose 15%, helped by a smaller foreign-exchange loss on U.S.-dollar debt, lower tax expense and share repurchases. Adjusted income declined 5% and adjusted diluted EPS increased 1%.
- For the first nine months, revenue fell 9% and adjusted diluted EPS fell 2%, while reported net income rose 18%, primarily reflecting favorable foreign-exchange effects on U.S.-dollar debt and lower income tax expense.
- Nine-month gross ton-miles declined 9%. Crude revenue fell 63% and Canadian grain revenue fell 12%; improved train speed, train weight and length, and fuel efficiency supported cost performance.
Outlook, commentary and notable items
- In an October 19, 2016 update, management projected full-year 2016 mid-single-digit diluted EPS growth from 2015 adjusted diluted EPS of $10.10, an operating ratio below 59%, and capital expenditures of approximately $1.2bn. Management attributed the revised outlook chiefly to a delayed grain harvest, sharply lower crude volumes, other weak economic factors and a stronger Canadian dollar; higher project costs also affected expected capital spending.
- Q3 included a $25m legal-settlement charge. Nine-month results included a net $153m non-cash gain from foreign-exchange translation of U.S.-dollar debt. The company’s adjusted measures exclude specified significant items and are not GAAP measures.
- CP repurchased 6.91m shares for $1.21bn during the first nine months and completed its issuer bid on September 28. Cash and share count were also affected by repurchases.
- Credit developments included a Moody’s negative outlook, a DBRS negative outlook and an August DBRS downgrade of unsecured debt to BBB and commercial paper to R-2 (middle); S&P affirmed stable ratings.
- Lac-Mégantic: CP disputed liability and said it would vigorously defend related proceedings. Quebec’s lawsuit sought $409m, and a separate ministerial notice sought nearly $95m. Other proceedings included insurer claims and a trustee claim involving asserted cargo and settlement-related amounts. CP said potential responsibility and losses could not be determined at this stage. Environmental remediation provisions were $85m, with payments expected through 2026.
- The CFO resigned effective September 9; Nadeem Velani was appointed interim CFO and named CFO on October 18. Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether freight volumes—especially crude and Canadian grain—and the delayed harvest support the revised full-year outlook.
- Progress against the below-59% operating-ratio target and approximately $1.2bn capital-spending plan.
- Cash generation, debt and leverage trends, including commercial-paper refinancing needs, interest coverage and credit-rating developments.
- Further developments, potential claim overlap and ultimate exposure in Lac-Mégantic litigation; the filing states that the outcome and amount cannot presently be determined.
- The composition and sustainability of reported earnings versus adjusted results, including foreign-exchange effects, tax effects, pension income and share repurchases.