Canadian Pacific Railway Limited — Q2 2020 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2020. Financial amounts are in Canadian dollars unless noted. The filing identifies the registrant as Canadian Pacific Railway Limited, not Canadian Pacific Kansas City Ltd.
Business context and results
CP operates a North American freight railway. Second-quarter results reflected COVID-19-related demand and shipment declines, partly offset by pricing, customer volume commitments, lower fuel costs, and operating efficiencies. CP completed its acquisition of Central Maine & Québec Railway’s U.S. operations on June 3, adding approximately 244 route-miles; the combined CMQ network also includes leased track.
Key financial metrics
| Metric | Q2 2020 | Q2 2019 | First half 2020 | First half 2019 |
|---|---|---|---|---|
| Revenue | $1.792bn | $1.977bn | $3.835bn | $3.744bn |
| Operating income | $770m | $822m | $1.604bn | $1.365bn |
| Net income | $635m | $724m | $1.044bn | $1.158bn |
| Diluted EPS | $4.66 | $5.17 | $7.64 | $8.25 |
| Adjusted diluted EPS (non-GAAP) | $4.07 | $4.30 | $8.49 | $7.08 |
| Operating ratio | 57.0% | 58.4% | 58.2% | 63.5% |
| Cash from operating activities | $835m | $721m | $1.324bn | $1.134bn |
| Capital additions | $502m | $459m | $857m | $683m |
| Free cash (non-GAAP) | $333m | $265m | $491m | $458m |
Q2 revenue fell 9% and net income fell 12%; adjusted diluted EPS declined 5%. Revenue ton-miles fell 10% in the quarter. For the first half, revenue rose 2% and operating income rose 18%, while net income declined 10%, principally reflecting foreign-exchange losses on U.S.-dollar debt and the prior-year Alberta tax-rate-change recovery. First-half adjusted diluted EPS increased 20%. Q2 operating-ratio improvement was attributed to fuel prices, pricing and liquidated damages, and operating efficiency, partly offset by lower volumes.
At June 30, cash was $277m versus $133m at year-end 2019. Long-term debt, including current maturities, was $9.548bn versus $8.757bn; total assets were $23.562bn and shareholders’ equity was $7.465bn. The $1.3bn revolving credit facility was undrawn, commercial paper borrowings were nil, and CP reported compliance with its credit-facility covenant. Adjusted net debt to adjusted EBITDA was 2.4x, unchanged year over year. The long-term-debt-to-net-income ratio was 4.1x, compared with 3.7x.
Material changes and unusual items
- Q2 freight revenue decreased $179m year over year, mainly from lower volumes. Automotive revenue fell 67%, metals, minerals and consumer products 35%, and coal 24%; grain revenue increased 6%.
- Operating expenses declined 12% in Q2, including a $81m benefit from lower fuel prices. Depreciation and amortization rose 7% in Q2 and 13% for the first half, reflecting a higher asset base.
- Reported Q2 other income included an $86m foreign-exchange gain on debt and lease liabilities; the first half recorded a $129m FX loss. These are excluded from CP’s adjusted results. The 2019 comparison also included an $88m deferred tax recovery from Alberta’s tax-rate change.
- CP issued $500m of U.S.-dollar 2.05% notes due 2030 and $300m of 3.05% notes due 2050 in Q1. It repurchased $520m of shares in the first half and declared $1.66 per share in dividends for that period.
- On July 21, after quarter-end, CP announced a quarterly dividend increase from $0.83 to $0.95 per share.
Outlook, risks and contingencies
- Updated July 22, CP expected year-over-year adjusted diluted EPS growth from the 2019 base of $16.44, RTMs down mid-single digits, and 2020 capital expenditures of $1.6bn. Assumptions included USD/CAD of about 1.35, an approximately 24.8% effective tax rate, and lower benefit-plan recovery. CP cautioned that it could not reconcile forward-looking adjusted EPS to GAAP without unreasonable effort.
- Management said COVID-19’s future effects remained uncertain. Demand weakness affected several freight lines; further impacts could arise from economic conditions, supply-chain or facility disruptions, employee absences, and market volatility affecting pension costs and funding.
- CP is defending multiple proceedings related to the 2013 Lac-Mégantic derailment. Claims include a Québec government claim reduced to $315m, a $95m cleanup-cost notice, and other claims, some unquantified. Management said responsibility and potential losses could not be determined; CP denies liability. The filing states management does not expect ordinary-course legal matters to have a material adverse effect, but the Lac-Mégantic outcome remains uncertain.
- Environmental remediation provisions were $82m at June 30, with payments expected through 2029; future costs may change and some potential charges cannot currently be quantified.
- Management estimated 2020 pension contributions of $40m–$50m, $25m below its prior estimate. The filing also notes safety rates worsened year over year in Q2, although first-half injury and accident rates improved.
Important facts for investors to verify
- How subsequent COVID-19 demand and shipment volumes compare with the mid-single-digit RTM decline assumed in the outlook.
- Whether the $1.6bn capital plan, adjusted EPS-growth outlook, and stated currency and tax assumptions remain current.
- Progress integrating CMQ and the final purchase-price allocation, which remained preliminary.
- Developments in Lac-Mégantic litigation and environmental obligations, given uncertain potential losses.
- Debt, liquidity, and cash generation trends, including the effect of FX translation and share repurchases on reported earnings and leverage.