CP

Business Context and Reporting Period

Company: Canadian Pacific Railway Limited (CP)

Filing Type: Form 6-K (Report of Foreign Issuer)

Reporting Period: First Quarter ended March 31, 2013

Date of Filing: April 24, 2013

CP is a transcontinental railway operating in Canada and the United States, providing freight transportation services for bulk commodities, merchandise, and intermodal traffic. The company reported record first-quarter results, driven by improved operating performance, higher traffic volumes, and increased freight rates, despite challenging winter conditions.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 9% year-over-year to a quarterly record of $1,495 million. Freight revenue rose 9% to $1,459 million, driven by higher volumes in Industrial and consumer products (+25%), Fertilizers and sulphur (+21%), and Coal (+9%).
• Profitability: Operating income surged 32% to $362 million. Net income increased 53% to $217 million. Diluted EPS improved 51% to $1.24.
• Efficiency: The operating ratio improved by 430 basis points to 75.8%, a quarterly record, reflecting efficiency savings and asset utilization improvements.
• Volume Metrics: Total Revenue Ton-Miles (RTMs) increased 10% to 36,163 million. Total carloads remained relatively flat (+0.5%) at 659,000, as higher volumes in bulk commodities offset declines in Automotive (-17%) and Intermodal (-4%).
• Operating Expenses: Total operating expenses increased 3% to $1,133 million. Increases were driven by higher volume variable expenses, depreciation, and stock-based compensation, partially offset by efficiency gains.

Guidance, Outlook, and Risks

Management Commentary and Outlook

CEO E. Hunter Harrison stated the company is on pace for the best year-end financial and operating performance in its history. The company is executing a transformational plan targeting a mid-60s operating ratio by 2016.

2013 Financial Expectations

• Revenue Growth: High single digits.
• Operating Ratio: Low 70s.
• Diluted EPS: In excess of 40% growth from 2012 annual diluted EPS (excluding significant items).
• Capital Spending: $1.0 billion to $1.1 billion.
• Key Assumptions: Average fuel cost of $3.45 USD/gallon; CAD/USD exchange rate at par; effective tax rate of 25-27%.

Risks and Contingencies

• Regulatory: Implementation of Positive Train Control (PTC) in the U.S. by 2015, estimated to cost up to $325 million USD. Potential changes to Canadian transportation laws regarding service contracts.
• Operational: Safety indicators showed deterioration in Q1 2013, with FRA personal injuries up 39% and train accidents up 25% compared to Q1 2012.
• Financial: Pension funding volatility remains a risk, though the company has made significant voluntary prepayments to mitigate this. Fuel price volatility is managed through cost recovery programs; the company exited its fuel hedging program in Q1 2013.
• Legal: A $20 million interest-free loan was provided to a court-appointed trustee regarding a building acquisition; title transfer depends on legal proceedings.

Investor Verification Checklist

• Safety Metrics: Verify the trend in FRA personal injury and train accident rates, which increased significantly in Q1 2013.
• Volume Mix: Confirm the sustainability of volume growth in Industrial/consumer products and Fertilizers, which offset declines in Intermodal and Automotive.
• Capital Expenditures: Monitor adherence to the $1.0B-$1.1B capital spending guidance, specifically the allocation for PTC implementation.
• Pension Obligations: Review the impact of recent pension plan amendments on future contribution requirements and net periodic benefit costs.
• Operating Ratio: Assess the ability to maintain the improved operating ratio (75.8%) given rising wage inflation and fuel costs.