CP

Business Context and Reporting Period

Company: Canadian Pacific Railway Limited (CP)
Filing Type: Form 6-K (Report of Foreign Private Issuer)
Reporting Period: First Quarter ended March 31, 2011
Filing Date: April 21, 2011
Business Overview: CP operates a North American transcontinental railroad providing freight transportation, logistics, and supply chain services. The quarter was significantly impacted by unusually severe winter weather, which constrained capacity, reduced shipping volumes, and increased operational costs.

Key Financial Metrics

Key Operational Data:
- Average Fuel Price: $3.12 USD/gallon (up 28% vs. prior year).
- Total Revenue Ton-Miles (RTM): 29,684 million (down 1.7%).
- Total Carloads: 605.9 thousand (down 3.1%).

Material Changes vs. Prior Period

• Revenue: Essentially flat year-over-year ($1.2 billion), despite a 1.3% increase in revenue per RTM. Volume declines in grain (-15.9% RTM) and coal (-7.8% RTM) offset growth in industrial/consumer products (+18.4% RTM) and sulphur/fertilizers (+10.9% RTM).
• Expenses: Operating expenses increased by $94.0 million (9.8%). This was driven primarily by a $44.0 million increase in fuel costs due to higher prices, and a $28.2 million increase in purchased services and other costs related to weather mitigation.
• Profitability: Operating income decreased by $97.4 million (47.1%) and Net Income decreased by $67.3 million (66.6%). The Operating Ratio deteriorated by 830 basis points to 90.6%.
• Cash Flow: Net cash provided by operating activities was $184.3 million, compared to $135.0 million in Q1 2010. However, cash and cash equivalents decreased by $50.1 million during the quarter due to investing and financing activities.

Guidance, Outlook, and Risks

Management Commentary: CEO Fred Green stated that while the first quarter was "extremely difficult" due to weather-related outages, demand remains strong. The company is focused on improving network velocity and service reliability. Management reiterated a long-term target of a low 70s operating ratio over a two- to four-year horizon.

Risks and Contingencies:

• Weather: Severe winter conditions significantly constrained capacity and service reliability.
• Commodity Prices: Exposure to diesel fuel price volatility, partially mitigated by fuel surcharge programs and hedging (diesel futures contracts covering ~5% of estimated purchases).
• Foreign Exchange: Exposure to fluctuations between Canadian and U.S. dollars, managed through natural offsets and FX forward contracts.
• Legal and Environmental: Ongoing legal actions and environmental remediation obligations (accrual of $104.6 million). Management believes these will not have a material adverse effect on financial position.
• Accounting Changes: Prior period figures were restated due to a change in accounting policy for rail grinding costs (expensed as incurred rather than capitalized).

Investor Verification Checklist

• Weather Impact Duration: Verify the extent to which severe winter weather impacts persist into Q2 2011 and the timeline for full network recovery.
• Fuel Hedging Effectiveness: Review the specific terms of the diesel futures contracts and the remaining exposure to rising fuel prices beyond the hedged 5%.
• Volume Recovery: Monitor grain and coal volume trends to confirm if the Q1 declines were purely weather-related or indicative of broader demand shifts.
• Operating Ratio Trajectory: Assess the feasibility of returning to the "low 70s" operating ratio target given the current 90.6% ratio and rising cost base.
• Capital Expenditures: Review the $375.8 million committed capital expenditures for 2011-2028 and the status of the Powder River Basin expansion project contingent payments.