Canadian Pacific Railway Limited — Q2 2018 Form 10-Q
Registrant note: The supplied filing is for Canadian Pacific Railway Limited, not a registrant named Canadian Pacific Kansas City Ltd. It covers the quarter and six months ended June 30, 2018. Financial figures are in Canadian dollars unless noted.
Business context and reporting period
CP is a North American freight railway. The filing reports unaudited results under U.S. GAAP. Comparatives for 2017 were not restated for the revenue standard adopted in 2018; pension-cost presentation was restated, with no effect on net income or EPS.
Financial results and key metrics
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Revenue | $1.750 billion | $1.643 billion | $3.412 billion | $3.246 billion |
| Operating income | $627 million | $611 million | $1.167 billion | $1.215 billion |
| Net income | $436 million | $480 million | $784 million | $911 million |
| Diluted EPS | $3.04 | $3.27 | $5.44 | $6.20 |
| Operating ratio | 64.2% | 62.8% | 65.8% | 62.6% |
| Cash from operations | $711 million | $611 million | $1.108 billion | $922 million |
| Free cash flow (non-GAAP) | $331 million | $274 million | $495 million | $361 million |
Q2 revenue rose 7%, led by 4% growth in revenue ton-miles, higher freight rates and fuel surcharges. Freight revenue gains were strongest in energy, chemicals and plastics, up 29%, and intermodal, up 7%; non-freight revenue declined 9%. Operating expenses increased 9%, including a $70 million increase in fuel expense. Operating income rose 3%, but net income fell 9%, primarily because of foreign-exchange losses on U.S.-dollar debt versus gains a year earlier.
For the first half, revenue increased 5%, while operating income declined 4% and net income declined 14%. The prior-year period included a $51 million management-transition recovery; 2018 also faced higher fuel costs, wage inflation and harsh winter conditions. Management’s non-GAAP adjusted diluted EPS was $3.16 for Q2, up 14%, and $5.85 for the first half, up 11%. Adjusted results exclude specified items and are not GAAP measures.
At June 30, cash was $51 million, versus $338 million at December 31, 2017. Total debt, including current maturities, was $8.483 billion, up from $8.159 billion; shareholders’ equity was $6.574 billion. First-half property additions were $654 million. CP reported $1.0 billion of undrawn revolving credit availability and $298 million of available letter-of-credit capacity. Commercial paper outstanding was US$45 million. The adjusted net debt/adjusted EBITDA ratio was 2.8, compared with 2.7 a year earlier; CP’s stated long-term target is 2.0–2.5.
Material changes, outlook and management commentary
- Labour negotiations disrupted service in Q2. After strike notices and rejected final offers, CP reached a tentative four-year agreement with the TCRC following a strike that began May 29; IBEW ratified a separate three-year agreement on June 29. Management attributed lower train speed and higher terminal dwell to the disruption.
- Q2 average train speed fell 8% to 21.4 mph and terminal dwell rose 16% to 6.7 hours year over year. Average train weight increased 4%; fuel efficiency improved 2%.
- CP raised its 2018 capital-expenditure outlook to $1.55 billion and announced more than a half-billion dollars of high-capacity grain hopper-car investment over four years. The filing provides no specific EPS or revenue guidance.
- Management expected a 2018 annualized effective tax rate of approximately 24.5%–25%. A $21 million deferred tax recovery from Iowa and Missouri tax-rate changes benefited Q2 reported results.
- The quarterly dividend was raised to $0.65 per share from $0.5625. CP repurchased 2.5 million shares for $559 million in the first half and completed its issuer bid in May.
- CP issued US$500 million of 4.000% 10-year notes due 2028, and repaid US$275 million and C$375 million of notes at maturity. Its US$1.0 billion revolving facility remained undrawn; the maturity of the remaining facility was extended to June 2023.
- New lease accounting was expected to materially increase recognized right-of-use assets and lease liabilities from 2019, with no material net-income effect anticipated.
Risks, contingencies and unusual items
- Foreign exchange movements on U.S.-dollar debt materially affected reported earnings: a $44 million Q2 loss and $93 million first-half loss in 2018, compared with gains of $67 million and $95 million in the corresponding 2017 periods. The filing says a C$0.01 weakening of the Canadian dollar would, on an annualized basis, increase revenue by about $27 million and operating expenses by about $14 million.
- Fuel prices were substantially higher: the average was US$2.79 per gallon in Q2 versus US$2.02, and US$2.74 for the first half versus US$2.06. Fuel surcharges offset part, but not all, of the expense increase.
- Lac-Mégantic-related litigation remains significant. The Province of Québec’s action seeks $315 million, the cleanup claim is $95 million, insurer claims include amounts of $14 million and $3 million, and other claims include unquantified damages. CP denies liability; management said potential liability and loss amount could not be determined. A liability trial was scheduled to begin in September 2019.
- Environmental remediation accruals were $81 million, with expected payments through 2028. The filing cautions that future environmental costs could differ and cannot be predicted with certainty.
- Contractual commitments totaled $22.807 billion, including debt, interest, leases and supplier purchases; separate capital commitments were $783 million. Management identified labour disputes, severe weather, fuel and currency movements, regulation, litigation and derailment-related liabilities among forward-looking risks.
Important facts for investors to verify
- Confirm the registrant identity and whether this historical Canadian Pacific Railway filing is the intended company record.
- Review the bridge from GAAP net income and EPS to management’s adjusted measures, especially FX debt losses and the $21 million tax recovery.
- Assess whether labour-related service disruption and elevated fuel costs persisted after the quarter, and whether planned grain-car spending affected capital needs.
- Track debt, liquidity, leverage against CP’s 2.0–2.5 target, and the impact of the 2019 lease-accounting adoption.
- Monitor developments in the Lac-Mégantic proceedings and environmental obligations; potential legal losses were not estimable in the filing.