Canadian Pacific Kansas City Limited (CPKC) — Q3 2023 Form 10-Q
Reporting period: Three and nine months ended September 30, 2023. Financial amounts are in Canadian dollars unless stated otherwise. CPKC operates an approximately 20,000-mile freight railway across Canada, the United States and Mexico.
Business context and comparability
CPKC assumed control of Kansas City Southern (KCS) on April 14, 2023 and consolidated its results from that date. Before control, KCS was accounted for as an equity investment. Accordingly, year-over-year comparisons are materially affected by including KCS in 2023 but not in reported 2022 results. Management also presents non-GAAP “core adjusted combined” measures to facilitate comparison; these exclude specified items and are not GAAP measures.
Financial performance
| Metric | Q3 2023 | Q3 2022 | Nine months 2023 | Nine months 2022 |
|---|---|---|---|---|
| Total revenue | $3.339B | $2.312B | $8.779B | $6.352B |
| Operating income | $1.173B | $937M | $2.946B | $2.340B |
| Net income attributable to controlling shareholders | $780M | $891M | $2.904B | $2.246B |
| Diluted EPS | $0.84 | $0.96 | $3.11 | $2.41 |
| Operating ratio | 64.9% | 59.5% | 66.4% | 63.2% |
| Core adjusted combined diluted EPS | $0.92 | $1.01 | $2.66 | $2.63 |
| Core adjusted combined operating ratio | 61.7% | 59.8% | 63.3% | 62.0% |
Q3 revenue rose 44%, including a $1.187B contribution from the KCS acquisition. Higher freight rates and grain volumes also supported revenue; lower volumes in potash, intermodal, crude and frac sand, and lower fuel surcharge revenue, partly offset gains. Freight revenue per revenue ton-mile increased 10%. Operating expenses increased 58% in Q3, reflecting the acquisition, purchase-accounting depreciation, inflation and operating inefficiencies. Q3 KCS contributed $328M to operating income and $224M to net income.
Reported Q3 diluted EPS decreased 13%; core adjusted combined diluted EPS decreased 9%. The reported nine-month results include a $7.175B KCS remeasurement loss and a $7.832B deferred tax recovery related to the acquisition. These acquisition-accounting and tax items heavily distort reported nine-month net income and EPS; the company reported a 166.83% nine-month effective tax rate, versus a 24.91% core adjusted rate.
Cash flow, balance sheet and liquidity
- Cash from operations: $1.027B in Q3, down 7% year over year, primarily due to the Mexican tax-audit settlement; $2.801B for nine months, up 16%.
- Capital additions: $733M in Q3 and $1.767B for nine months. Cash used in investing was $742M and $1.761B, respectively.
- Cash: $294M at September 30, 2023, down from $451M at December 31, 2022. Nine-month cash used in financing was $1.202B.
- Debt: Current maturities of $1.784B plus long-term debt of $21.762B, or $23.546B total, compared with $19.651B at year-end 2022. Debt fair value was $20.656B. Net interest expense was $207M in Q3 and $565M for nine months.
- Funding capacity: The $2.2B revolving credit facility was undrawn; $406M of commercial paper was outstanding at a 5.54% weighted-average rate. CPKC reported compliance with its credit-facility covenant. Credit ratings were BBB+ (S&P) and Baa2 (Moody’s), both with stable outlooks.
- Capital returns: Dividends declared were $0.19 per share in Q3 and $0.57 for nine months, unchanged from 2022. Share repurchases were suspended, with no active program at quarter-end.
Outlook, management commentary and material risks
Management said available cash, operating cash flow and financing capacity are adequate for short- and long-term requirements, and reported no known material liquidity deficiency. The company expects a 2023 core adjusted annualized effective tax rate of approximately 25%; it provided no broader earnings or revenue guidance in the supplied filing text. Management noted that interim results may be affected by seasonality and are not necessarily indicative of full-year results.
- Integration and regulatory conditions: Benefits from the KCS combination are not assured. STB conditions include open-gateway commitments, environmental requirements, data reporting and seven years of oversight; integration may be costly or disruptive.
- Legal and tax matters: Appeals remain in the Lac-Mégantic litigation after a 2022 trial decision dismissed claims against CPKC; potential responsibility and losses cannot currently be determined. A Remington ruling set damages at $165M plus interest and costs, estimated at approximately $215M in total; allocation between CPKC and Alberta remains undetermined and CPKC has appealed. CPKC also contests a Mexican 2014 tax assessment of Ps.5.525B (reported as $424M). The filing describes other Mexican tax contingencies.
- Mexico exposures: CPKC Mexico’s refundable VAT balance was $10M at quarter-end; the company believes it is recoverable. The Mexican rail concession runs to 2047, subject to conditions and renewal requirements; revocation or termination could materially affect operations.
- Environmental and operational matters: Environmental remediation provisions were $231M, including acquired KCS liabilities, with payments expected through 2032. The EPA and DOJ are discussing alleged locomotive-related Clean Air Act noncompliance; no final violations, corrective-action demand or preliminary penalty assessment had been issued.
- Other drivers: Fuel-price movements, foreign exchange, labor availability and costs, weather, commodity and trade demand, safety incidents, and potential service interruptions may affect results. A $51M insurance recovery for prior B.C. wildfire and flood business-interruption losses reduced Q3 operating expense.
Most important facts for investors to verify
- Separate acquisition-driven growth from underlying performance, and review both reported results and the company’s non-GAAP combined measures.
- Track operating-ratio trends, train productivity and fuel efficiency; Q3 fuel efficiency worsened 12% year over year, partly due to lower average train weights after the acquisition.
- Monitor debt, interest costs, capital spending and cash generation as integration and network investment continue.
- Follow KCS purchase-price allocation adjustments, integration progress, and the realization of projected growth and synergies.
- Review developments in the Remington appeal, Lac-Mégantic proceedings, Mexican tax/VAT matters, EPA/DOJ discussions, and STB oversight conditions.