Business Context and Reporting Period
This Form 6-K filing by Canadian Pacific Railway Limited and Canadian Pacific Railway Company, dated December 4, 2012, outlines a strategic transformation plan presented by President and CEO E. Hunter Harrison. The filing details a "rapid change agenda" initiated over the first 160 days of Harrison's tenure, focusing on operational efficiency, cost reduction, and service reliability to position the railway as a low-cost carrier.
Key Financial Metrics and Operational Data
The filing provides forward-looking financial expectations for 2016 rather than historical financial statements for the reporting period. Key metrics include:
- Operating Ratio (OR): Targeted to reach the mid-60s by 2016.
- Revenue Growth: Projected compound annual growth of 4% to 7% off the 2012 base.
- Cash Flow: Expected cash flow before dividends of $900 million to $1,400 million in 2016.
- Capital Spending: Annual range of $1.0 billion to $1.1 billion over the period.
- Asset Reduction: Already achieved a reduction of 195 locomotives and 3,200 leased rail cars; total stored, returned, or surplus locomotives year-to-date total 460.
- Workforce: Plan to reduce approximately 4,500 employee and/or contractor positions by 2016, with 1,700 expected to be eliminated by year-end 2012.
Material Changes and Strategic Actions
Significant operational changes have been implemented to improve velocity and reduce costs:
- Network Optimization: Closure of hump-switching yards in Toronto, Winnipeg, Calgary, and Chicago, and intermodal terminals in Milwaukee, Obico, and Schiller Park.
- Service Improvements: Revamped intermodal and merchandise train services resulting in faster transit times, including new connections between Vancouver and Chicago/Toronto.
- Leadership Restructuring: Implementation of a new executive leadership team with centralized planning and decentralized execution.
- Real Estate: Plans to relocate corporate headquarters from downtown Calgary to CP-owned Ogden Yard by 2014 and explore options for surplus real estate.
- Asset Disposition: Seeking expressions of interest for the 660-mile portion of the former Dakota, Minnesota & Eastern (DM&E) west of Tracy, Minnesota, and reviewing options for the Delaware & Hudson (D&H) line.
Guidance, Outlook, and Risks
Management anticipates a strong earnings profile and solid free cash flow emerging from the transformation. Key assumptions underpinning the 2016 guidance include an average fuel cost of $3.45 per U.S. gallon, a tax rate of 25% to 27%, and a Canadian to U.S. exchange rate at par.
Unusual Items and Charges: The company anticipates a fourth-quarter 2012 pre-tax non-cash charge of approximately $180 million ($107 million after tax) related to the option to build into the Powder River Basin. Additionally, a charge related to labor and restructuring activities is expected, though the amount is under review.
Risks: The filing includes standard forward-looking statements cautioning that actual results may differ due to economic conditions, commodity prices, weather, labor disputes, regulatory changes, and pension plan uncertainties.
Investor Verification Checklist
- Verify the magnitude of the $180 million non-cash charge and the final amount of the labor/restructuring charge in the Q4 2012 earnings release.
- Monitor progress on the reduction of 4,500 positions and the specific impact on operating costs.
- Track the execution of the siding program and its effect on crew starts and train velocity.
- Assess the outcome of the review for the Delaware & Hudson line and the sale of the DM&E portion.
- Confirm the actual 2012 operating ratio to establish a baseline for the mid-60s 2016 target.