Business Context and Reporting Period
Company: Canadian Pacific Railway Limited (CP)
Filing Type: Form 6-K (Report of Foreign Issuer)
Reporting Period: Third Quarter ended September 30, 2013 (Interim)
Date of Filing: October 23, 2013
Overview: CP reported record quarterly earnings and its lowest operating ratio in company history. The results reflect a transformational journey focused on service execution and cost control, achieving earnings growth despite a softer volume environment in certain sectors.
Key Financial Metrics
| Metric | Q3 2013 | Q3 2012 | YTD 9M 2013 | YTD 9M 2012 |
|---|---|---|---|---|
| Total Revenues | C$1,534 million | C$1,451 million | C$4,526 million | C$4,193 million |
| Operating Income | C$524 million | C$376 million | C$1,306 million | C$889 million |
| Net Income | C$324 million | C$224 million | C$793 million | C$469 million |
| Diluted EPS | C$1.84 | C$1.30 | C$4.50 | C$2.72 |
| Adjusted EPS (excl. significant items) | C$1.88 | C$1.30 | C$4.49 | C$3.07 |
| Operating Ratio | 65.9% | 74.1% | 71.1% | 78.8% |
| Free Cash Flow (YTD) | C$318 million | C$21 million | ||
| Total Assets (Sept 30, 2013) | C$15,734 million | |||
| Long-Term Debt (Sept 30, 2013) | C$4,591 million |
Material Changes vs. Prior Period
- Revenue Growth: Total revenues increased 6% in Q3 and 8% YTD, driven by higher freight rates, favorable foreign exchange impacts, and increased volumes in Industrial and consumer products, Fertilizers, and Coal.
- Expense Reduction: Operating expenses decreased 6% in Q3 and 3% YTD. This was primarily due to efficiency savings from improved asset utilization, insourcing of IT activities, and reduced workforce (average employees down 15% in Q3).
- Profitability Surge: Net income increased 45% in Q3 and 69% YTD. The Operating Ratio improved by 820 basis points in Q3 and 770 basis points YTD, reaching a record low of 65.9%.
- Volume Trends: While total Revenue Ton-Miles (RTMs) increased 2% in Q3 and 7% YTD, specific segments like Automotive and Intermodal saw volume declines, offset by growth in bulk commodities.
Guidance, Outlook, and Risks
Management Commentary and Outlook
- 2013 Full Year Expectations: Management expects revenue growth in the high single digits, an operating ratio in the low 70s, and diluted EPS growth exceeding 40% compared to 2012.
- Capital Spending: Planned capital expenditures for 2013 are up to C$1.2 billion, including an acceleration of certain projects.
- Long-Term Strategy: CP targets a mid-60s operating ratio by 2016 and compound annual revenue growth of 4%-7% off the 2012 base.
Risks and Contingencies
- Lac-Megantic Litigation: CP was added as a named party in a class action and cleanup order regarding the July 2013 Lac-Megantic derailment. CP denies liability; potential loss is currently undeterminable, and no accrual has been recognized.
- Executive Transition: CFO Brian Grassby announced his retirement, with a search for a successor underway. He will remain through year-end to ensure a smooth transition.
- Regulatory and Environmental: Risks include changes in grain revenue caps, Positive Train Control (PTC) implementation costs (estimated up to US$325 million), and environmental remediation obligations.
- Foreign Exchange: Results are sensitive to the CAD/USD exchange rate; a strengthening CAD reduces reported earnings.
Investor Verification Checklist
- Adjusted EPS Reconciliation: Verify the C$7 million tax expense related to the British Columbia corporate tax rate change included in the Q3 results.
- Lac-Megantic Liability: Monitor legal proceedings regarding the Lac-Megantic derailment for any updates on potential liability or cleanup costs.
- Capital Expenditure Execution: Track the execution of the C$1.2 billion capital program, specifically the C$60 million allocated for PTC compliance.
- Volume Mix: Assess the sustainability of volume growth in Industrial/consumer products and Fertilizers against declines in Automotive and Intermodal.
- Workforce Reduction: Confirm the impact of the 18% workforce reduction on operational efficiency and service levels.