Business Context and Reporting Period
Company: Canadian Pacific Railway Limited (CP)
Filing Type: Form 6-K (Report of Foreign Issuer)
Reporting Period: First Quarter ended March 31, 2015
Release Date: April 21, 2015
Business Overview: CP operates a transcontinental railway in Canada and the United States, providing freight transportation services for bulk commodities, merchandise, and intermodal traffic across a network of approximately 13,700 miles.
Key Financial Metrics
| Metric (CAD Millions) | Q1 2015 | Q1 2014 |
|---|---|---|
| Total Revenues | $1,665 | $1,509 |
| Operating Income | $612 | $423 |
| Net Income | $320 | $254 |
| Diluted EPS (GAAP) | $1.92 | $1.44 |
| Adjusted Diluted EPS (Non-GAAP) | $2.26 | $1.42 |
| Operating Ratio | 63.2% | 72.0% |
| Cash from Operating Activities | $555 | $287 |
| Free Cash Flow (Non-GAAP) | $312 | $15 |
| Total Assets | $17,249 | $17,315 |
| Long-Term Debt | $6,358 | $5,659 |
Material Changes vs. Prior Period
- Revenue Growth: Revenues increased 10% to a record $1.67 billion, driven by higher traffic volumes in most lines of business (grain, potash, chemicals, intermodal) and favorable foreign exchange impacts.
- Operating Efficiency: The Operating Ratio (OR) improved by 880 basis points to a record low of 63.2%. This was primarily due to efficiency savings, lower fuel expenses (down 28% due to lower prices and better efficiency), and higher land sales.
- Profitability: Net income rose 26% to $320 million. Adjusted earnings per share increased 59% to $2.26.
- Foreign Exchange Impact: A $64 million charge (after-tax $55 million) related to foreign exchange translation on U.S. dollar-denominated debt negatively impacted reported earnings. Excluding this item, underlying performance was significantly stronger.
- Share Repurchases: The company repurchased 2.17 million shares for $490 million in Q1 2015, compared to 0.57 million shares for $87 million in Q1 2014.
Guidance, Outlook, and Risks
Management Commentary and Guidance
Management expressed confidence in the company's plan and people, citing a business model that responds nimbly to economic shifts. Full-year 2015 financial expectations include:
- Revenue Growth: 7-8%.
- Operating Ratio: Below 62%.
- Adjusted EPS Growth: 25% or greater compared to 2014.
- Capital Expenditures: Approximately $1.5 billion.
- Key Assumptions: CAD/USD exchange rate of $1.20; average fuel price of US$2.70; income tax rate of 27.5%.
Risks and Contingencies
- Lac-Mégantic Litigation: CP is a defendant in class action lawsuits and administrative proceedings related to the July 2013 derailment in Lac-Mégantic, Quebec. While CP denies liability, a Plan of Arrangement in the Montreal Maine and Atlantic Railway (MM&A) bankruptcy seeks to distribute a $293 million fund. CP has not contributed to this fund and objects to the release of responsible parties.
- Regulatory Changes: Ongoing discussions regarding the transportation of hazardous commodities, including new tank car standards and potential liability caps (Bill C-52 in Canada).
- Labour Relations: Approximately 77% of the workforce is unionized. A tentative four-year settlement was reached with Unifor in Q1 2015. CP is currently in binding arbitration with the Teamsters Canada Rail Conference regarding locomotive engineers and conductors.
- Asset Sale: CP finalized an agreement to sell a portion of the Delaware and Hudson Railway line to Norfolk Southern for approximately US$215 million, subject to regulatory approval.
Investor Verification Checklist
- FX Sensitivity: Verify the impact of the CAD/USD exchange rate on future earnings, as a significant portion of debt and operations are USD-denominated.
- Adjusted vs. GAAP EPS: Confirm the reconciliation of the $0.34 per share difference between GAAP and Adjusted EPS caused by the FX translation charge on debt.
- Share Count: Monitor the reduction in outstanding shares due to the aggressive share repurchase program (NCIB) and its effect on future EPS.
- Legal Exposure: Track the status of the Lac-Mégantic litigation and the MM&A bankruptcy plan approval, as potential liabilities remain uncertain.
- Capital Discipline: Review the execution of the $1.5 billion capital program, specifically the allocation between track/roadway (70%) and rolling stock (10%).