CP

Business Context and Reporting Period

Company: Canadian Pacific Railway Limited (CP)

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

Reporting Period: Third Quarter ended September 30, 2012 (and Year-to-Date)

Date of Filing: October 24, 2012

Overview: CP operates a transcontinental railway in Canada and the U.S., providing freight transportation, logistics, and supply chain services. The period was marked by significant management transition, including the appointment of E. Hunter Harrison as President and CEO in June 2012, and the implementation of operational improvements aimed at increasing network fluidity and reducing costs.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 8% in Q3 and 11% YTD, driven by higher freight rates, increased volumes in industrial/consumer products, automotive, and intermodal sectors, and favorable foreign exchange impacts.
• Profitability Improvement: Net income rose 20% in Q3 and 34% YTD. The Operating Ratio improved by 170 basis points in Q3 and 360 basis points YTD, reflecting better operational efficiency and asset utilization.
• Expense Management: Operating expenses increased 6% in Q3 and 6% YTD. Increases were driven by higher compensation (including stock-based), depreciation, and volume-related costs, partially offset by efficiencies and land sales.
• Operational Metrics: Average train speed increased 11% in Q3 and 19% YTD. Average terminal dwell decreased 4% in Q3 and 14% YTD. Active cars on-line decreased significantly (18% in Q3), indicating improved network fluidity.
• Management Transition Costs: A one-time charge of $38 million was recorded in Q2 2012 related to the CEO transition (compensation and advisory fees), impacting YTD results.

Guidance, Outlook, and Risks

• Management Commentary: CEO E. Hunter Harrison stated that momentum is building with new services, closed terminals, and a new leadership team. The focus remains on operational improvements and cost control.
• Capital Expenditures: 2012 capital programs are expected to range between $1.1 billion and $1.2 billion, focused on asset preservation, network enhancements, and regulatory requirements (Positive Train Control).
• Pension Outlook: Defined benefit pension contributions are estimated at $100 million to $125 million annually through 2016. Pension expense for 2012 is expected to be $41 million, rising to approximately $125 million in 2013.
• Key Risks:
  • Labor Relations: A nine-day strike occurred in Q2 2012; arbitration hearings are scheduled for December 2012 regarding Canadian running trades.
  • Regulatory: Implementation of Positive Train Control (PTC) in the U.S. by 2015 is estimated to cost up to $325 million.
  • Market Volatility: Exposure to fuel price fluctuations, foreign exchange rates, and commodity demand (grain, coal, potash).

Investor Verification Checklist

• Strike Resolution: Monitor the outcome of the arbitration hearings scheduled for December 2012 regarding Canadian labor contracts.
• Capital Spending: Verify if actual capital expenditures remain within the $1.1B-$1.2B guidance, particularly regarding PTC implementation costs.
• Pension Volatility: Track investment returns and interest rate changes, as these significantly impact pension funding requirements and future expenses.
• Operational Efficiency: Confirm if the improvements in train speed and terminal dwell are sustainable and translating into long-term cost reductions.
• Commodity Volumes: Assess the impact of weaker potash demand and grain production levels on future revenue mix.