Business context and reporting period
Canadian Pacific Railway Limited (CP), a Canadian freight railway, filed this unaudited Form 10-Q for the quarter ended June 30, 2017. Financial amounts are in Canadian dollars unless otherwise noted. The filing cautions that interim results are not necessarily indicative of full-year results.
Financial performance and position
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Revenue | $1,643 million | $1,450 million | $3,246 million | $3,041 million |
| Operating income | $679 million | $551 million | $1,350 million | $1,204 million |
| Net income | $480 million | $328 million | $911 million | $868 million |
| Diluted EPS | $3.27 | $2.15 | $6.20 | $5.67 |
| Adjusted diluted EPS (non-GAAP) | $2.77 | $2.05 | $5.27 | $4.55 |
| Operating ratio | 58.7% | 62.0% | 58.4% | 60.4% |
| Cash from operations | $611 million | $512 million | $922 million | $730 million |
| Free cash (non-GAAP) | $274 million | $190 million | $361 million | $173 million |
For the first half, capital additions were $576 million. At June 30, cash and cash equivalents were $238 million; reported debt was $8.422 billion, including $762 million due within one year and $7.660 billion long-term. Total assets were $19.537 billion and shareholders’ equity was $5.333 billion. CP also had an undrawn U.S. $2.0 billion revolving credit facility and no commercial paper borrowings.
Material changes versus prior comparable periods
- Q2 revenue grew 13%, operating income 23%, and net income 46% year over year. Management attributed operating improvement chiefly to higher volumes, pension income, operating efficiencies and better asset utilization. Q2 adjusted diluted EPS rose 35%, excluding significant items.
- Q2 freight revenue rose 14%, with revenue ton-miles up 12%; growth included grain, frac sand, coal, potash, crude and domestic intermodal. Automotive and some other freight categories declined.
- Q2 operating expenses increased 7%, notably from higher fuel costs, workload, foreign exchange and stock-based compensation; these pressures were partly offset by pension income and efficiency gains.
- First-half net income rose 5%, while adjusted diluted EPS increased 16%. Comparisons include a $51 million CEO-transition recovery in 2017 and 2016 gains from the Arbutus Corridor and surplus freight-car sales.
- Operating performance was mixed: terminal dwell improved 11% in Q2, but average train speed fell 3%. FRA personal-injury and train-accident rates increased year over year in both Q2 and the first half.
- Cash from operations and free cash increased year over year in the first half. Share repurchases were $143 million in the first half, versus $788 million in the prior-year period; declared dividends per share increased.
Outlook, management commentary, risks and unusual items
- For full-year 2017, CP expected adjusted diluted EPS growth in the high single digits from 2016 adjusted diluted EPS of $10.29, excluding future repurchases and the CEO-transition recovery. Assumptions included CAD/USD of $1.30–$1.35, WTI oil at U.S. $45–$55 per barrel, and a normalized tax rate of approximately 26.5%.
- Planned 2017 capital investment was approximately $1.25 billion, about 6% above 2016. CP estimated 2017 pension contributions of $50–$60 million.
- Q2 reported results included a $67 million foreign-exchange gain on U.S.-dollar debt, a $17 million deferred tax recovery from a Saskatchewan tax-rate change, a $10 million insurance recovery, and a $13 million charge related to hedge roll and de-designation. First-half results also included the $51 million CEO-transition recovery. Management’s adjusted measures exclude specified significant items and are not GAAP measures.
- CP described the $2.0 billion credit facility as available and stated it complied with its financial covenant. Adjusted net debt to adjusted EBITDA was 2.7 times, above its stated long-term target range of 2.0–2.5 times. Moody’s revised its outlook to stable from negative during the quarter.
- Material contingencies include Lac-Mégantic-related litigation. Québec has asserted a $409 million damages claim and a separate cleanup claim of nearly $95 million; CP disputes liability. CP stated potential responsibility and losses could not be determined at this early stage and intends to defend the proceedings. Environmental remediation accruals were $83 million, with payments expected through 2026.
- CP identified possible effects from proposed Canadian rail legislation (Bill C-49), regulation, safety and environmental requirements, fuel and currency fluctuations, weather, pension funding, litigation and operational disruptions. The bill’s enactment timing was uncertain.
- Accounting outlook: adoption of the leases standard in 2019 was expected to materially increase recognized assets and liabilities, with no anticipated material income-statement impact. CP did not expect a material revenue-recognition change from the 2018 customer-contract standard.
Most important facts for investors to verify
- Whether volume growth and operating efficiencies persist, and whether the higher reported and adjusted EPS growth translates into sustainable earnings.
- The composition of earnings: especially foreign-exchange gains on U.S.-dollar debt, tax recoveries and the CEO-transition item; compare GAAP results with CP’s non-GAAP reconciliations.
- Debt maturities, access to committed liquidity, and progress toward the stated adjusted net debt/EBITDA target.
- Developments in Lac-Mégantic proceedings and the potential effect of any court decisions, settlements or cleanup obligations; the filing does not provide a clear estimate of ultimate exposure.
- Safety trends, Bill C-49’s final provisions, and any resulting effects on service, pricing, costs or capital spending.
- Progress against the 2017 adjusted EPS and capital-investment outlook, including the assumptions and exclusions used in that guidance.