Canadian Pacific Railway Limited — Q1 2021 Form 10-Q
Reporting period: Three months ended March 31, 2021; comparative figures are for Q1 2020. Unless noted otherwise, figures are in Canadian dollars. The filing is by Canadian Pacific Railway Limited, not Canadian Pacific Kansas City Ltd., which was the planned name of the combined company.
Financial results and position
| Metric | Q1 2021 | Q1 2020 / comparator |
|---|---|---|
| Revenue | $1.959 billion | $2.043 billion; down 4% |
| Operating income | $780 million | $834 million; down 6% |
| Operating ratio | 60.2% | 59.2%; worsened 100 basis points |
| Net income | $602 million | $409 million; up 47% |
| Diluted EPS | $4.50 | $2.98; up 51% |
| Adjusted diluted EPS | $4.48 | $4.42; up 1% |
| Cash from operations | $582 million | $489 million |
| Free cash flow (non-GAAP) | $296 million | $158 million |
| Long-term debt, including current portion | $9.740 billion | $9.771 billion at Dec. 31, 2020 |
Revenue declined chiefly because of foreign-exchange effects and lower fuel-surcharge revenue tied to recovery timing. Freight revenue fell 4%; energy, chemicals and plastics revenue decreased 21%, while grain rose 7%, coal 9% and automotive 24%. Operating income was pressured by fuel prices, KCS-related transaction costs, stock-based compensation and depreciation, partly offset by operating efficiencies and a $50 million gain on a Chicago property/easement exchange.
Reported net income and EPS benefited substantially from a $33 million foreign-exchange gain on U.S.-dollar debt and lease liabilities, compared with a $215 million loss in Q1 2020. The $50 million property-exchange gain also benefited operating results. Adjusted income was $600 million, down 1%, and adjusted operating income was $813 million, down 3%. Adjusted operating ratio improved to 58.5% from 59.2%; these adjusted measures are non-GAAP.
At March 31, cash and equivalents were $360 million, versus $147 million at year-end 2020. Total assets were $24.121 billion and shareholders’ equity was $7.866 billion. Cash used in investing was $286 million and cash used in financing was $80 million. Adjusted net debt to adjusted EBITDA was 2.4 times for the trailing 12 months, within the company’s stated long-term target of 2.0–2.5 times.
Material changes and operating performance
- Volumes were broadly steady: carloads increased slightly to 691,400 and revenue ton-miles rose slightly to 39.273 billion. Grain and coal gains were offset by lower crude and international intermodal volumes.
- Operating efficiency indicators improved: average train weight rose 7% and train length 8%; fuel efficiency improved 1%. Average terminal dwell increased 19%, train speed fell 3%, and reported FRA personal-injury and train-accident rates worsened year over year.
- Operating cash flow increased 19% year over year, which management attributed primarily to working-capital changes, including cash received for future property easements. Capital additions were $323 million.
- Moody’s downgraded the company’s rating to Baa2 from Baa1 following announcement of the proposed KCS acquisition; S&P ratings were unchanged, with a stable outlook.
Outlook, transaction and key risks
Management forecast high-single-digit 2021 revenue-ton-mile growth and double-digit adjusted diluted EPS growth, based on 2020 adjusted diluted EPS of $17.67. It planned approximately $1.55 billion of 2021 capital investment and assumed a 24.6% effective tax rate. The guidance excludes potential effects of the pending KCS transaction and is forward-looking; management said it could not reconcile the adjusted EPS outlook to GAAP without unreasonable effort.
On March 21, 2021, CP agreed to acquire Kansas City Southern in a cash-and-stock transaction with an announced enterprise value of approximately US$29 billion, including assumption of US$3.8 billion of KCS debt. KCS common shareholders were to receive 0.489 CP shares and US$90 cash per share, subject to the merger terms and the subsequent five-for-one CP share split. The transaction required shareholder and regulatory approvals; the voting-trust step was expected in the second half of 2021 and completion was expected by mid-2022. CP obtained commitments for a US$8.5 billion, 364-day bridge facility and said it planned to issue approximately 44.5 million new shares for the stock consideration, adjusted for the split. Management expected leverage to rise temporarily to about 4.0 times and targeted a return to its 2.0–2.5 range within 36 months after the voting-trust closing.
Risks include failure or delay in obtaining approvals, competing bids, integration challenges, transaction costs, management distraction and substantial additional debt. Certain termination circumstances could require a US$700 million fee; specified regulatory-related circumstances could trigger a US$1 billion fee payable by CP. The filing also identifies risks from COVID-19, fuel and currency movements, commodity demand, weather, regulation, safety incidents, labor, environmental matters and access to financing.
CP reported that it was defending claims relating to the 2013 Lac-Mégantic derailment. The Quebec government’s amended claim was $315 million, in addition to other proceedings; management said potential responsibility and losses could not then be determined. CP denied liability. Environmental remediation provisions were $81 million at quarter-end. The five-for-one share split was approved April 21, 2021, after quarter-end, with a May 13 effective date for holders of record May 5.
Important facts for investors to verify
- Progress toward KCS shareholder and regulatory approvals, transaction timing, final consideration and financing needs.
- Whether projected 2021 volume and adjusted EPS growth, capital spending and the leverage trajectory are achieved; review non-GAAP reconciliations and assumptions.
- Underlying operating trends excluding the Chicago property-exchange gain and FX effects, including fuel-surcharge recovery timing and the weak energy/chemicals and intermodal businesses.
- Debt costs, credit ratings, covenant flexibility and liquidity after any acquisition financing; the bridge facility is acquisition financing, not unrestricted cash.
- Developments in Lac-Mégantic and other legal matters, environmental liabilities, and the worsening safety indicators disclosed for the quarter.