Canadian Pacific Kansas City Limited (CPKC) — Q1 2023 Form 10-Q
Reporting period: Three months ended March 31, 2023. Financial statements are in Canadian dollars unless otherwise noted. KCS was accounted for as an equity-method investment during the quarter; CPKC assumed control and began consolidating KCS on April 14, 2023. Accordingly, Q1 reported results are not the combined company’s consolidated results.
Financial performance and position
| Metric | Q1 2023 | Q1 2022 | Change |
|---|---|---|---|
| Total revenue | $2.266 billion | $1.838 billion | +23% |
| Operating income | $829 million | $535 million | +55% |
| Net income | $800 million | $590 million | +36% |
| Diluted EPS | $0.86 | $0.63 | +37% |
| Operating ratio | 63.4% | 70.9% | Improved 750 bps |
| Cash from operations | $881 million | $613 million | +44% |
| Cash used in investing | $401 million | $206 million | Capital additions increased |
| Cash used in financing | $645 million | $391 million | Higher net cash use |
- Freight revenue rose 23% to $2.217 billion. Carloads increased 9%, revenue ton-miles increased 11%, and freight revenue per ton-mile increased 11%. Growth reflected higher volumes and yield, including fuel surcharges, higher freight rates, and favorable foreign exchange.
- Operating expenses increased 10% to $1.437 billion, less than revenue growth. Higher workload, inflation, foreign exchange, and fuel costs were partly offset by improved fuel efficiency and lower pension service and stock-based compensation costs.
- Management reported core adjusted diluted EPS of $0.90, up 35%, and adjusted operating ratio of 62.9%, improved 690 bps. These are non-GAAP measures; Q1 adjustments included acquisition-related costs and an outside-basis deferred tax recovery.
- Free cash, a non-GAAP measure, was $495 million versus $424 million. Dividends declared were $0.19 per share, unchanged year over year.
- At March 31, cash and cash equivalents were $290 million, versus $451 million at year-end. Total debt, including current maturities, was $19.162 billion, down from $19.651 billion. The $1.3 billion U.S. revolving credit facility was undrawn; no commercial paper was outstanding. The company reported compliance with its credit-facility covenant.
- Q1 capital additions were $405 million, compared with $226 million. The company repaid $479 million of notes at maturity. Long-term debt to net income was 5.1 times for the trailing twelve months, versus 6.9 times; combined adjusted net debt to combined adjusted EBITDA was 3.6 times, versus 4.1 times. Management’s long-term target for the latter is 2.0–2.5 times.
Material changes and transaction developments
- The Surface Transportation Board approved the KCS merger on March 15, subject to conditions. Control transferred on April 14, after quarter-end; KCS’s results and cash flows are to be consolidated prospectively from that date.
- Following control, CPKC remeasured its previously held KCS investment at a provisional fair value of $37.2 billion, compared with its approximate $44.4 billion carrying value. The filing estimates a preliminary $7.2 billion remeasurement loss and an approximately $7.8 billion deferred tax recovery. These are post-quarter transaction accounting estimates, not Q1 operating results.
- The provisional purchase price allocation estimates $19.7 billion of identifiable net assets and $18.5 billion of goodwill. The allocation remains subject to review and adjustment during the measurement period of up to 12 months.
- In April, $3.014 billion of KCS notes were exchanged for corresponding CPRC notes with substantially the same financial terms. KCS also deposited $647 million of government securities to discharge obligations on two 2023 note series.
Outlook, risks and contingencies
- Management expects an approximately 25.5% annual effective tax rate for 2023 after KCS control, excluding specified discrete items and effects related to the former equity investment. The filing provides no overall revenue or earnings guidance.
- Management said operating cash flow, available financing, and debt capacity are adequate for expected cash requirements. Foreign exchange, fuel prices, inflation, demand, weather, labor availability, and operating disruptions may affect results. A one-cent weakening of the Canadian dollar versus the U.S. dollar is estimated to increase annual revenue by about $36 million, while increasing operating expenses by about $21 million and net interest expense by about $4 million.
- Integration of KCS may be costly or disruptive, and anticipated benefits are not assured. STB conditions include gateway-access commitments, environmental requirements, reporting obligations, and seven years of oversight.
- Material legal matters include the appealed dismissal of claims related to the Lac-Mégantic derailment, with potential responsibility and losses not determinable; an appealed Alberta ruling estimating approximately $200 million in damages before costs in the Remington matter, with CPKC’s share not reasonably estimable; and ongoing EPA/DOJ discussions concerning alleged locomotive-related Clean Air Act noncompliance, for which no final violations, penalty assessment, or outcome was provided.
- Risks also include environmental remediation uncertainty and Mexican concession, regulatory, political, currency, and trade exposure. The Mexican rail concession runs to 2047 and is renewable subject to conditions.
Most important facts for investors to verify
- How KCS consolidation, provisional purchase accounting, and the large remeasurement and tax entries affect subsequent reported earnings, debt, and cash flow.
- Whether integration delivers expected operating and commercial benefits while meeting STB conditions and the leverage target.
- Progress on the Remington appeal, Lac-Mégantic appeals and remaining proceedings, and the EPA/DOJ matter.
- Whether revenue growth and operating-ratio improvement persist as fuel surcharges, freight volumes, foreign exchange, and costs change.
- Changes in liquidity, debt maturities, capital spending, and the provisional KCS purchase price allocation.