Canadian Pacific Railway Limited — Q3 2022 Form 10-Q
Reporting period: Three and nine months ended September 30, 2022. Financial amounts are in Canadian dollars unless stated otherwise. Although the request identifies Canadian Pacific Kansas City Ltd., this filing is for Canadian Pacific Railway Limited (CP); it reports its KCS investment under the equity method while regulatory approval to control KCS remained pending.
Financial performance
| Metric | Q3 2022 | Q3 2021 | First 9 months 2022 | First 9 months 2021 |
|---|---|---|---|---|
| Revenue | $2,312 million | $1,942 million | $6,352 million | $5,955 million |
| Operating income | $937 million | $774 million | $2,340 million | $2,374 million |
| Net income | $891 million | $472 million | $2,246 million | $2,320 million |
| Diluted EPS | $0.96 | $0.70 | $2.41 | $3.46 |
| Operating ratio | 59.5% | 60.2% | 63.2% | 60.1% |
| Cash from operations | $1,102 million | $548 million | $2,422 million | $3,084 million |
- Q3 revenue rose 19% and operating income increased 21%. Management attributed the improvement to higher freight volumes and rates, a favourable $84 million fuel-price impact on operating income, and lower casualty costs; inflation and lower crude liquidated damages partly offset gains.
- Q3 net income rose 89%, including $221 million of equity earnings from KCS. Core adjusted diluted EPS, a non-GAAP measure, increased 15% to $1.01. The reported diluted EPS comparison also reflects more shares outstanding following the KCS acquisition.
- For the first nine months, revenue increased 7%, but operating income declined 1% and net income declined 3%. The 2021 comparison included an $845 million KCS merger termination fee; 2022 included $627 million of KCS equity earnings. Nine-month diluted EPS fell 30%, while core adjusted diluted EPS fell 6% to $2.63.
- Q3 adjusted operating ratio was 58.7%, improving 70 basis points year over year. The nine-month adjusted operating ratio was 62.3%, worsening 460 basis points, reflecting inflation, lower volumes and less favourable operating conditions, among other factors.
- Freight revenue grew 19% in Q3, with revenue ton-miles up 6%. Intermodal revenue rose 45% and potash revenue rose 50%; energy, chemicals and plastics revenue fell 8%. Nine-month revenue ton-miles declined 4%, including weaker Canadian grain, coal, and energy, chemicals and plastics volumes.
Cash, debt and liquidity
- Q3 cash from operations was $1.102 billion; cash used in investing was $410 million, including $422 million of property additions. Company-defined free cash was $721 million. For the first nine months, free cash was $1.514 billion.
- At September 30, cash was $138 million; total debt, including current maturities, was $20.575 billion. The KCS investment was carried at $45.964 billion. Total assets were $73.435 billion and shareholders’ equity was $37.814 billion.
- The U.S. $1.3 billion revolving credit facility was undrawn. Commercial paper borrowings were U.S. $525 million, or approximately $720 million, and the company reported compliance with its credit-facility covenant. The U.S. $500 million term facility was repaid and terminated in September.
- Trailing-twelve-month adjusted net debt to adjusted EBITDA was 4.3x; the pro forma measure including KCS was 4.1x. Management’s long-term target for adjusted net debt to adjusted EBITDA is 2.0x–2.5x. These are non-GAAP measures.
Outlook, developments and risks
- The filing gives an expected 2022 annualized effective tax rate of 24.00%–24.50%, excluding KCS equity earnings and other discrete items. It provides no broad earnings or revenue forecast in the text supplied.
- CP expected the Surface Transportation Board’s review of the proposed KCS control application to conclude in Q1 2023; the filing cautions that approval and completion were not assured. Until approval, KCS remained in a voting trust and CP accounted for it using the equity method.
- In August, CP entered a two-year collective agreement with the TCRC, effective January 1, 2022, including 3.5% wage increases in 2022 and 2023 and increased benefits. A March work stoppage had reduced Q1 volumes; service was restored after employees returned to work.
- Material exposures include fuel and FX volatility, inflation, weather and operating disruptions, labour matters, regulatory approval and integration risks, and litigation. A stronger U.S. dollar increases translated revenue and costs; the filing estimates that a $0.01 Canadian-dollar weakening would annually increase revenue by about $35 million, operating expenses by about $20 million and net interest expense by about $4 million.
- CP continued to defend claims arising from the 2013 Lac-Mégantic derailment; management said potential responsibility and losses could not be determined. Separately, an October 20, 2022 Alberta court decision—after quarter-end—found CP liable in a property-sale dispute, with damages estimated at about $200 million before costs and allocation between CP and Alberta. CP said it could not yet reasonably estimate its share, recorded no accrual at September 30, and planned to appeal.
- Environmental remediation provisions were $85 million, with expected payments through 2031. Management stated ordinary-course legal actions were not expected to have a material adverse effect, while noting an unexpected adverse outcome could be material.
Important facts for investors to verify
- Progress and final outcome of STB approval for CP’s proposed control of KCS, and the related financing, integration and deleveraging implications.
- Whether Q3 volume, pricing and operating-ratio improvements persist, given weaker nine-month volumes, inflation, fuel costs and service-efficiency indicators.
- Debt and liquidity trends, including commercial paper usage, interest expense and progress toward the stated long-term leverage target.
- Developments in the Lac-Mégantic proceedings and the appeal, damages allocation and potential accrual in the Remington matter.
- Reported GAAP results alongside management’s non-GAAP adjusted measures; the latter exclude selected acquisition, purchase-accounting and other items and may not be comparable across companies.