Business context and reporting period
Canadian Pacific Railway Limited (CP) filed this Form 10-K for the fiscal year ended December 31, 2022; it is an annual report, not a standalone fourth-quarter filing. The company operated a roughly 13,000-mile freight railway across Canada and the United States. Amounts below are in Canadian dollars unless stated otherwise.
At filing, CP owned KCS economically but held its shares in a voting trust and did not control or consolidate KCS. Pending Surface Transportation Board (STB) approval, KCS results were recorded using the equity method. The combined company was expected to be named Canadian Pacific Kansas City Limited.
Key financial metrics
| Metric | 2022 | 2021 | Change |
|---|---|---|---|
| Total revenue | $8.814 billion | $7.995 billion | +10% |
| Operating expenses | $5.485 billion | $4.789 billion | +15% |
| Operating income | $3.329 billion | $3.206 billion | +4% |
| Net income | $3.517 billion | $2.852 billion | +23% |
| Diluted EPS | $3.77 | $4.18 | -10% |
| Operating ratio | 62.2% | 59.9% | +2.3 percentage points |
| Adjusted operating ratio (non-GAAP) | 61.4% | 57.6% | +3.8 percentage points |
| Cash from operating activities | $4.142 billion | $3.688 billion | +12% |
| Cash used in investing activities | $1.496 billion | $13.730 billion | Lower, mainly because 2021 included KCS acquisition payments |
Higher revenue reflected fuel surcharges, freight rates and favorable foreign exchange, despite a 1% decline in revenue ton-miles. Fuel surcharge revenue was $1.303 billion, up 144%, and represented about 15% of freight revenue. Fuel expense rose 64% to $1.400 billion, largely due to higher fuel prices. Adjusted diluted EPS was $3.77 in both years; reported EPS was affected by significant and acquisition-related items and the larger share count following the KCS transaction.
Debt, liquidity and capital
At year-end, cash and cash equivalents were $451 million, compared with $69 million a year earlier. Long-term debt, including amounts due within one year, was $19.651 billion. CP reported an undrawn $1.3 billion U.S.-dollar revolving credit facility, no commercial paper outstanding, and $75 million of letters of credit drawn against $300 million of capacity. Management said available liquidity, operating cash flow and debt capacity were adequate for expected cash requirements.
Operating cash flow included $1.157 billion of KCS dividends. Cash capital investment was $1.557 billion in 2022; CP expected approximately $1.6 billion of standalone capital investment in 2023, excluding any additional investment following control of KCS. The 2022 dividend declared was $0.76 per share. Share repurchases remained suspended.
CP’s pro forma adjusted net debt to pro forma adjusted EBITDA ratio, including KCS, was 3.8x, versus 4.0x in 2021; management’s long-term target was 2.0x–2.5x. These are non-GAAP measures. Credit ratings were BBB+ (S&P) and Baa2 (Moody’s), both with stable outlooks.
Material changes versus 2021
- Reported revenue increased, but operating expenses rose faster, and the operating ratio worsened. Adjusted operating ratio also deteriorated.
- Net income rose, while diluted EPS declined, reflecting the substantially higher weighted-average share count after shares were issued for KCS and changes in significant items.
- CP recognized $1.074 billion of KCS equity earnings for the full year, compared with a $141 million equity loss for the 18-day period in 2021. The 2022 amount included a $212 million after-purchase-accounting-and-tax gain related to KCS’s unwinding of interest-rate hedges.
- Net interest expense increased 48% to $652 million, primarily due to debt issued for the KCS acquisition.
- Volumes were mixed: Intermodal revenue increased 30% and Potash revenue 25%; Energy, chemicals and plastics fell 11%, and Coal fell 8%. Canadian grain volumes were affected by drought-related crop conditions.
- Gross ton-miles declined 1%; fuel efficiency worsened 3%, partly reflecting harsh winter conditions and lower locomotive productivity.
Outlook, commentary, risks and unusual items
Management’s stated strategy remained precision scheduled railroading, emphasizing service, cost control, asset utilization, safety and workforce development. The filing gives no clear full-year 2023 revenue or EPS guidance. It forecast a 2023 effective tax rate of approximately 24%, excluding specified discrete and KCS-related items, and standalone capital spending of about $1.6 billion.
The STB review of CP’s proposed control of KCS was expected to conclude in the first quarter of 2023, but approval, timing and conditions were uncertain. If approval was not received, or management judged it would not be received, before March 25, 2023, CP could be required to redeem specified 2.450% notes due 2031 and 3.000% notes due 2041 at 101% of principal plus accrued interest. If approval was not obtained by December 31, 2023, or was finally denied, CP would generally have to divest its KCS investment. The filing warns that a sale could cause significant losses and expenses.
Other notable items include $123 million of 2022 KCS acquisition-related costs; a $24 million deferred-tax recovery reversing a prior uncertain tax position; and the KCS hedge-unwind gain noted above. CP also disclosed a $7.526 billion deferred tax liability associated with its KCS investment and said that obtaining control would trigger significant purchase-accounting and tax-accounting changes.
Key risks include fuel and inflation costs, labor negotiations and staffing, severe weather and network disruption, hazardous-material incidents, environmental compliance, cybersecurity, pension assumptions, and regulatory changes. A March 2022 labor interruption was resolved through binding arbitration; the resulting TCRC agreement runs through December 31, 2023.
Contingencies include an appealed 2022 Quebec court decision dismissing claims against CP related to the Lac-Mégantic derailment; remaining litigation in the United States; a separate North Dakota claim with the value of lost crude still to be determined; and an appealed Alberta judgment concerning Remington Development. The court found CP liable, but CP said its share of damages could not yet be reasonably estimated; total damages were then estimated at about $200 million before Remington’s costs. The EPA had issued notices alleging potential Clean Air Act non-compliance involving locomotives, and DOJ had requested discussions; the filing said the likely outcome and any penalty were not yet clear.
The financial statements received an unqualified audit opinion, and the auditor also reported effective internal control over financial reporting. The auditor identified measurement of the Canadian defined-benefit pension obligation, particularly the discount rate, as a critical audit matter.
Most important facts an investor should verify
- Subsequent STB decisions, any imposed conditions, and the resulting status and economics of the KCS combination, including any note-redemption or divestiture obligations.
- How much of revenue and operating cash flow growth is durable versus attributable to fuel surcharges, higher rates, currency translation and KCS dividends.
- Debt-service capacity and the path toward management’s 2.0x–2.5x long-term pro forma leverage target.
- Developments, potential exposure and insurance coverage related to the environmental, Remington and Lac-Mégantic matters.
- Whether service productivity, fuel efficiency and operating margins recover after the 2022 deterioration, and whether the 2023 capital plan is delivered as expected.