Business Context and Reporting Period
Company: Canadian Pacific Railway Limited (CP)
Filing Type: Form 6-K (Report of Foreign Private Issuer)
Reporting Period: Second Quarter ended June 30, 2011 (Year-to-Date)
Business Overview: CP operates a North American transcontinental railway providing freight transportation, logistics, and supply chain services. The quarter was significantly impacted by widespread and prolonged flooding along the right of way, resulting in nearly 90 separate outages, traffic rerouting, and increased operating costs.
Key Financial Metrics
| Metric (CAD Millions) | Q2 2011 | Q2 2010 | YTD 2011 | YTD 2010 |
|---|---|---|---|---|
| Total Revenues | $1,264.5 | $1,234.2 | $2,427.9 | $2,401.0 |
| Operating Expenses | $1,034.0 | $960.1 | $2,088.2 | $1,920.3 |
| Operating Income | $230.5 | $274.1 | $339.7 | $480.7 |
| Net Income | $128.0 | $166.6 | $161.7 | $267.6 |
| Diluted EPS | $0.75 | $0.98 | $0.95 | $1.58 |
| Operating Ratio | 81.8% | 77.8% | 86.0% | 80.0% |
| Cash & Equivalents (End of Period) | $267.8 | $373.6 | $267.8 | $373.6 |
| Long-Term Debt | $3,918.8 | $4,033.2 | $3,918.8 | $4,033.2 |
Note: All figures are in millions of Canadian dollars unless otherwise specified. Fuel prices increased 37% to $3.50 U.S. per gallon in Q2 2011.
Material Changes vs. Prior Period
- Revenue Growth: Total revenues increased by $30.3 million (2.5%) in Q2 2011 compared to Q2 2010, driven by higher freight volumes in certain sectors despite operational disruptions.
- Expense Increase: Operating expenses rose by $73.9 million (7.7%) in Q2 2011. This was primarily due to a 33.4% increase in fuel costs and higher "Purchased services and other" expenses related to flood mitigation and traffic rerouting.
- Profitability Decline: Operating income decreased by $43.6 million (15.9%) and Net Income fell by $38.6 million (23.2%) year-over-year in Q2 2011.
- Operating Ratio Deterioration: The operating ratio worsened by 400 basis points to 81.8% in Q2 2011 (from 77.8% in Q2 2010) and by 600 basis points to 86.0% year-to-date.
- Commodity Mix: Grain revenue declined 9.2% YTD due to lower volumes, while Sulphur and fertilizers revenue increased 31.0% YTD.
Guidance, Outlook, and Risks
Management Commentary: CEO Fred Green stated that service levels are returning to normal following the completion of flood repairs. The company incurred significantly higher operating costs to ensure customer delivery during the disruptions. No specific forward-looking financial guidance for the full year was provided in this filing.
Risks and Contingencies:
- Weather and Operations: Severe weather conditions (flooding) caused significant operational outages and cost increases.
- Commodity Prices: Volatility in diesel fuel prices remains a key risk, though partially mitigated by fuel cost recovery programs and hedging.
- Legal and Environmental: The company maintains provisions for legal actions and environmental remediation ($103.2 million accrual). Management believes these will not have a material adverse effect on financial position.
- Contingent Payments: Potential future payments of up to US$1.1 billion related to the Dakota, Minnesota & Eastern Railroad Corporation (DM&E) acquisition, contingent on construction and volume milestones by 2025.
Investor Verification Checklist
- Flood Impact Duration: Verify if the "return to normal" service levels mentioned by management has fully materialized in subsequent months and if residual costs persist.
- Fuel Hedging Effectiveness: Review the extent of fuel cost recovery from shippers versus the actual fuel price volatility experienced in Q3 and Q4.
- Grain Volume Trends: Investigate the reasons behind the 9.2% year-to-date decline in grain revenue and whether this reflects a seasonal anomaly or a structural shift in agricultural demand.
- DM&E Contingent Liabilities: Assess the likelihood of triggering the US$1.1 billion contingent payment milestones for the DM&E expansion project.
- Debt Maturity Profile: Confirm the schedule for long-term debt maturities, particularly the US$101.4 million and US$175.0 million notes hedged with FX forwards maturing in 2013 and 2018.