CP

Business Context and Reporting Period

Company: Canadian Pacific Railway Limited (CP)

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

Reporting Period: Second Quarter ended June 30, 2011 (Interim)

Filing Date: July 28, 2011

Business Overview: CP operates a transcontinental railway in Canada and the United States, providing freight transportation, logistics, and supply chain services. The network spans approximately 14,700 miles, connecting principal business centers from Montreal to Vancouver and into the U.S. Northeast and Midwest.

Key Financial Metrics

Note: All figures are in Canadian dollars unless otherwise specified. Free Cash Flow is a non-GAAP measure.

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 2.5% in Q2 2011 compared to Q2 2010, driven by higher freight rates and fuel cost recovery, partially offset by lower traffic volumes and unfavorable foreign exchange (FX) impacts.
• Profitability Decline: Operating income decreased 15.9% ($43.6 million) and Net Income decreased 23.2% ($38.6 million) year-over-year. The Operating Ratio worsened by 400 basis points to 81.8%.
• Cost Pressures: Operating expenses rose 7.7% due to:
  • Fuel Costs: Average fuel price increased 37% to $3.50 U.S. per gallon, driving a 33.4% increase in fuel expenses.
  • Weather Disruptions: Extensive flooding in Saskatchewan and North Dakota caused nearly 90 track outages, leading to inefficient operations, rerouting costs, and higher crew/material expenses.
  • IT Investments: Increased costs related to SAP and shipment management platform improvements.
• Volume Trends: Total carloads decreased 4.3% in Q2 2011. Grain and Intermodal volumes declined significantly due to flooding and weather, while Sulphur and Fertilizers volumes increased 25.7%.

Guidance, Outlook, and Risks

• Management Commentary: CEO Fred Green noted that service levels are returning to normal following the completion of flood repairs. The company expects to realize benefits from demand growth in bulk, merchandise, and intermodal lines.
• Capital Expenditures: 2011 capital spending is estimated between $950 million and $1.05 billion, a significant increase from 2010, focused on track renewal, volume growth, and IT upgrades.
• Pension Contributions: Estimated aggregate pension contributions for 2011 are between $100 million and $125 million.
• Tax Rate: The effective income tax rate for 2011 is expected to be in the 24% to 26% range.
• Key Risks:
  • Severe Weather: Continued exposure to floods, avalanches, and extreme temperatures.
  • Regulatory: Implementation of Positive Train Control (PTC) in the U.S. by 2015, estimated to cost up to $250 million U.S.
  • Commodity Prices: Volatility in fuel prices and foreign exchange rates (CAD strengthened ~5% vs USD).
  • Labour Relations: Ongoing collective agreement negotiations with various unions in Canada and the U.S.

Investor Verification Checklist

• Flood Impact Duration: Verify the extent of residual operational inefficiencies and cost impacts from the Q2 flooding events into Q3 and Q4.
• Fuel Hedging Effectiveness: Review the specific terms and coverage of the diesel futures contracts (approx. 6% of estimated purchases) against rising market prices.
• Capital Program Execution: Monitor the $950M-$1.05B capital expenditure plan, specifically the $80M allocated to IT systems and $40M for PTC compliance.
• Pension Fund Performance: Assess the impact of market returns and discount rate changes on the defined benefit pension plan deficit and future funding requirements.
• FX Exposure: Evaluate the impact of the strengthening Canadian dollar on U.S. dollar-denominated revenues and debt obligations.