Canadian Pacific Railway Limited — Q2 2021 Form 10-Q
Reporting period: Three and six months ended June 30, 2021. Unless noted otherwise, amounts are Canadian dollars. The filing registrant is Canadian Pacific Railway Limited; the supplied company label referencing Kansas City does not match the registrant named in the filing.
Business context and financial performance
CP is a freight railroad operator. Q2 results benefited from a recovery in freight volumes and higher revenue per revenue ton-mile, as well as an $845 million KCS merger termination fee. The fee materially boosts reported earnings, so adjusted results provide additional context. Per-share amounts reflect the five-for-one share split.
| Metric | Q2 2021 | Q2 2020 | Six months 2021 | Six months 2020 |
|---|---|---|---|---|
| Total revenue | $2,054 million | $1,792 million | $4,013 million | $3,835 million |
| Operating income | $820 million | $770 million | $1,600 million | $1,604 million |
| Net income | $1,246 million | $635 million | $1,848 million | $1,044 million |
| Diluted EPS | $1.86 | $0.93 | $2.76 | $1.53 |
| Adjusted income | $689 million | $553 million | $1,289 million | $1,160 million |
| Adjusted diluted EPS | $1.03 | $0.81 | $1.92 | $1.70 |
| Operating ratio | 60.1% | 57.0% | 60.1% | 58.2% |
| Adjusted operating ratio | 55.3% | 57.0% | 56.8% | 58.2% |
Revenue rose 15% in Q2, with freight revenue up 15% and revenue ton-miles up 9%. Higher volumes and freight rates supported operating income; higher fuel costs, acquisition expenses and other cost increases partly offset those gains. The Q2 adjusted operating ratio improved 170 basis points, while the reported ratio worsened 310 basis points, principally reflecting acquisition-related costs and fuel.
Cash flow, debt and liquidity
- Q2 cash from operating activities was $1,954 million, versus $835 million; six-month cash from operations was $2,536 million, versus $1,324 million. Management attributed much of the increase to the termination fee and favorable working capital, including customer receipts in advance of service.
- Q2 free cash, a non-GAAP measure, was $746 million, versus $333 million; six-month free cash was $1,042 million, versus $491 million. Capital additions were $416 million in Q2 and $739 million for the six months.
- Cash and cash equivalents were $892 million at June 30, 2021, compared with $147 million at December 31, 2020. Long-term debt, including current maturities, was $8,722 million, down from $9,771 million. No commercial paper was outstanding, and the $1.3 billion revolving credit facility was undrawn.
- Adjusted net debt to adjusted EBITDA was 2.0 for the twelve months ended June 30, compared with 2.4 a year earlier; CP stated a long-term target range of 2.0–2.5. This is a non-GAAP measure.
- Dividends declared were $0.190 per share in Q2 and $0.380 per share for the six months, compared with $0.166 and $0.332, respectively, in 2020.
Material changes, outlook and risks
- KCS transaction: CP’s proposed acquisition of Kansas City Southern, announced at an enterprise value of approximately U.S. $29 billion, ended when KCS terminated the agreement on May 21, 2021 to pursue an agreement with CN. KCS paid CP an $845 million termination fee. CP said it remained available to re-engage. CP also incurred acquisition-related costs of $308 million in Q2 and $344 million in the first half; these costs include operating expenses and hedge and financing-related items. Adjusted measures exclude specified significant items and are not GAAP measures.
- 2021 outlook: Management expected high-single-digit RTM growth and double-digit adjusted diluted EPS growth, based on 2020 adjusted diluted EPS of $3.53. The outlook assumed a 24.6% effective tax rate, approximately $40 million more in other components of net periodic benefit recovery versus 2020, and approximately $1.55 billion of capital investment. Forward adjusted EPS is not reconciled to GAAP because management cited uncertainty and unknown variables.
- Operations and costs: Q2 fuel expense rose 66% to $218 million, reflecting higher fuel prices and workload. Network activity increased as demand recovered, while average terminal dwell rose 5% and train speed fell 3% year over year. Management cited higher fuel prices, inflation, labor and training costs, foreign exchange, and execution of its capital program among factors affecting results.
- Contingencies: CP is defending claims arising from the 2013 Lac-Mégantic derailment. Potential responsibility and losses could not be determined; Quebec claims include an amended $315 million government action and an unquantified class action. Trials were scheduled for September 2021. Environmental remediation accruals were $80 million, with expected payments through 2030; additional costs could arise as estimates and circumstances change.
- Financing and hedges: CP filed to issue up to U.S. $8.5 billion of debt securities over 25 months. After the KCS deal ended, hedge accounting ceased for transaction-related instruments. If forecast debt is not issued, up to $73 million of accumulated swap losses could be reclassified to expense, plus up to $2 million related to bond locks.
- Moody’s downgraded CP’s rating to Baa2 from Baa1 in Q1, citing the proposed KCS transaction; the outlook was stable at June 30. The company reported no material change to its previously disclosed risk factors and stated that disclosure controls were effective.
Important facts for investors to verify
- Separate underlying operating momentum from the $845 million termination fee and the $308 million of Q2 acquisition-related costs; review the company’s non-GAAP reconciliations and exclusions.
- Assess the sustainability of reported operating cash flow, given the termination-fee receipt and favorable working-capital movements, including advance customer receipts.
- Track freight volumes, pricing, fuel-cost recovery timing, service measures, and whether the 2021 growth and adjusted EPS outlook assumptions are achieved.
- Monitor debt issuance plans, hedge-loss treatment if planned debt is not issued, liquidity, and credit-rating implications.
- Follow the Lac-Mégantic litigation and environmental obligations, where potential outcomes or future costs remain uncertain.