Business context and reporting period
This is Canadian Pacific Railway Limited’s unaudited Form 10-Q for the quarter and nine months ended September 30, 2020; financial amounts are in Canadian dollars unless otherwise stated. The filing predates the later Canadian Pacific Kansas City name. CP operates a North American freight railway, with results affected by COVID-19-related demand changes and the December 2019 acquisition of Central Maine & Québec Railway; control of CMQ U.S. began June 3, 2020.
Financial results and position
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Revenue | $1.863bn | $1.979bn | $5.698bn | $5.723bn |
| Operating income | $779m | $869m | $2.383bn | $2.234bn |
| Net income | $598m | $618m | $1.642bn | $1.776bn |
| Diluted EPS | $4.41 | $4.46 | $12.04 | $12.70 |
| Adjusted diluted EPS (non-GAAP) | $4.12 | $4.61 | $12.62 | $11.68 |
| Operating ratio | 58.2% | 56.1% | 58.2% | 61.0% |
| Cash from operations | $493m | $823m | $1.817bn | $1.957bn |
| Free cash (non-GAAP) | $6m | $363m | $497m | $821m |
At September 30, 2020, cash was $183m, total debt including current maturities was $9.786bn, and shareholders’ equity was $7.579bn. The company had an undrawn U.S.$1.3bn revolving credit facility, U.S.$345m of commercial paper outstanding, and $61m of letters of credit drawn under $300m of bilateral facilities. The reported long-term-debt-to-net-income ratio was 4.2; adjusted net debt to adjusted EBITDA was 2.5.
Material changes versus prior periods
- Q3 revenue fell 6% and operating income fell 10%; net income declined 3% and diluted EPS declined 1%. Lower freight volumes, including COVID-19-affected traffic, and higher stock-based compensation weighed on operating performance. Q3 adjusted diluted EPS fell 11%.
- Q3 freight revenue declined 6%; revenue ton-miles fell 6%. Grain and Potash grew, while Coal, Energy, chemicals and plastics, and Metals, minerals and consumer products weakened. Management attributed lower volumes in several lines to the pandemic.
- For the first nine months, revenue was nearly flat and operating income rose 7%, but net income fell 8% and diluted EPS fell 5%. A 2019 tax-rate-change recovery and year-over-year foreign-exchange effects contributed to the net-income comparison. Adjusted diluted EPS increased 8%.
- Q3 operating ratio worsened by 210 basis points year over year, while the nine-month ratio improved by 280 basis points. Lower fuel costs and operating efficiencies helped; reduced volumes, cost inflation, casualty costs and share-price-sensitive compensation were offsets.
- Nine-month operating cash flow fell 7%; capital additions were $1.341bn versus $1.147bn. Free cash declined to $497m from $821m. Q3 operating cash flow was particularly affected by working capital and deferred tax payments made during the quarter.
Outlook, commentary, risks and unusual items
On October 20, 2020, CP forecast at least mid-single-digit 2020 adjusted diluted EPS growth year over year, using 2019 adjusted diluted EPS of $16.44 as the base. It expected RTMs to decline by a low-single-digit percentage and maintained capital expenditure guidance of $1.6bn. Assumptions included CAD/USD of $1.35, an approximately 24.8% effective tax rate and a decrease of approximately $40m in other components of net periodic benefit recovery versus 2019. The company stated it could not reconcile forward-looking adjusted EPS to GAAP without unreasonable effort.
Management reported improved operating efficiency: Q3 average train weight increased 7% and train length increased 9% year over year. It also reported better safety indicators. COVID-19’s future effects remained uncertain; the filing identifies potential demand, supply-chain, employee-availability, seasonal and pension impacts. Other stated risks include severe weather, fuel and currency fluctuations, derailments, litigation, labour issues, regulation and climate change.
Unusual items include a $40m Q3 foreign-exchange gain on U.S.-dollar debt and lease liabilities, compared with a $25m loss in Q3 2019; the nine-month 2020 period included an $89m FX loss. Q3 stock-based compensation expense was $56m versus $15m a year earlier, with share-price changes a major driver. The filing describes unresolved Lac-Mégantic-related proceedings, including a Québec government claim reduced to $315m and other claims; CP denies liability, and management said potential responsibility and losses could not be determined. Environmental remediation accruals were $81m, payable over time. Subsequent to quarter-end, CP agreed to buy OMERS’ 83.5% interest in the Detroit River Tunnel Partnership for approximately U.S.$312m, subject to closing conditions and regulatory approvals.
Important facts for investors to verify
- Confirm the identity and reporting history: this filing is for Canadian Pacific Railway Limited, not a company already operating under the later Canadian Pacific Kansas City name.
- Review COVID-19-related volume assumptions and whether the revised 2020 guidance was achieved; guidance uses non-GAAP adjusted EPS.
- Assess the cash-flow decline, capital spending, share repurchases and dividend commitments together. CP repurchased shares for $945m and paid $339m in dividends during the first nine months.
- Monitor debt, commercial paper, liquidity and the 2.5 adjusted net-debt-to-adjusted-EBITDA ratio, which is at the upper end of management’s stated 2.0–2.5 long-term target.
- Track the Lac-Mégantic proceedings, environmental obligations and the proposed Detroit River Tunnel acquisition, including final costs and approvals.