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, 2010 (Year-to-Date also provided)

Business Overview: CP operates a transcontinental railway in Canada and the United States, providing freight transportation, logistics, and supply chain expertise. The company transports bulk commodities (grain, coal, sulphur, fertilizers), merchandise freight (automotive, forest products, industrial goods), and intermodal traffic.

Key Financial Metrics

Note: Adjusted metrics exclude foreign exchange gains/losses on long-term debt and other specified items (e.g., asset sales).

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 15% in Q3 2010 compared to Q3 2009, driven by a 13.9% increase in volume (Revenue Ton-Miles) and higher fuel surcharge revenues. Freight revenues rose 15.1%.
• Profitability: Reported Net Income decreased 6% to $197.3 million, primarily due to a $68.1 million after-tax gain on real estate sales in Q3 2009 that did not recur. However, Adjusted Net Income increased 27% to $204.7 million, reflecting underlying operational strength.
• Operating Efficiency: The Adjusted Operating Ratio improved by 270 basis points to 73.7%, indicating better cost management relative to revenue growth.
• Volume Trends: Significant volume increases were seen in Sulphur and Fertilizers (+45.5% RTM), Automotive (+39.0% RTM), and Intermodal (+17.5% RTM). Coal volumes were relatively flat.
• Foreign Exchange: The strengthening Canadian dollar had an unfavorable impact on reported revenues and expenses, reducing total freight revenue per carload by approximately 2.7% in Q3.

Guidance, Outlook, and Risks

• Capital Expenditures: CP expects 2010 capital spending to range between $750 million and $800 million, focused on rail renewal, ballast, crossties, and Positive Train Control (PTC) implementation.
• Pension Funding: The company made a voluntary prepayment of $650 million to its main Canadian defined benefit pension plan in Q3 2010. Total 2010 pension contributions are estimated between $835 million and $845 million (including the prepayment). Future contributions are expected to be $150 million to $200 million annually for the next 3-5 years.
• Interest Coverage: The interest coverage ratio (12-month rolling) improved to 4.0x as of September 30, 2010, up from 3.1x in the prior year.
• Key Risks:
  • Economic Sensitivity: Freight volumes depend heavily on North American and global economic conditions.
  • Regulatory: Implementation of Positive Train Control (PTC) by 2015 is estimated to cost up to $250 million. Grain revenue caps and rate regulations also pose risks.
  • Labour: Approximately 78% of the workforce is unionized; negotiations are ongoing for several bargaining units.
  • Commodity Prices: Fuel price volatility remains a risk, though mitigated by fuel cost recovery programs and hedging.

Investor Verification Checklist

• Adjusted vs. GAAP Earnings: Verify the reconciliation of GAAP Net Income to Adjusted Net Income to understand the impact of the 2009 real estate sale and foreign exchange fluctuations on long-term debt.
• Pension Liability: Review the funded status of the defined benefit pension plan and the impact of the $650 million voluntary prepayment on future cash flow requirements.
• Foreign Exchange Exposure: Assess the sensitivity of future earnings to fluctuations in the CAD/USD exchange rate, given the significant portion of debt and operations in U.S. dollars.
• Capital Commitments: Confirm the timeline and cost estimates for the Positive Train Control (PTC) implementation and other capital projects.
• Volume Mix: Monitor the sustainability of volume growth in key sectors like Automotive and Intermodal, which drove the recent revenue increase.