CP

Business Context and Reporting Period

Company: Canadian Pacific Railway Limited (CP)

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

Reporting Period: First Quarter ended March 31, 2010

Filing Date: April 28, 2010

Accounting Standard: U.S. GAAP (adopted effective January 1, 2010; prior periods restated for comparison)

CP operates a transcontinental railway in Canada and the United States, transporting bulk commodities, merchandise freight, and intermodal traffic. The quarter reflected early signs of economic recovery, with management citing improvements in the economy and the company's ability to adjust to customer demands.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 5.2% driven by higher freight volumes (Total Carloads +8.5%; Revenue Ton-Miles +16.5%) and increased fuel surcharge revenues. This was partially offset by an unfavorable foreign exchange (FX) impact of approximately $87 million on U.S. dollar-denominated revenue.
• Cost Management: Operating expenses decreased 1.6% to $961.8 million. Savings were driven by a favorable FX impact of ~$71 million, lower material costs (fewer locomotive overhauls), and reduced equipment rents. These were partially offset by higher fuel prices and increased traffic-related expenses.
• Profitability: Operating income surged 55.1% due to revenue growth and cost efficiencies. The operating ratio improved significantly to 82.4%.
• Segment Performance:
  • Sulphur & Fertilizers: Revenues up 54.6% due to increased export potash volumes.
  • Automotive: Revenues up 49.5% due to increased North American auto sales.
  • Intermodal: Revenues up 6.8% driven by domestic container shipments.
  • Grain & Coal: Revenues declined 5.7% and 5.2% respectively, impacted by negative rate decisions and FX headwinds.
• Foreign Exchange: The Canadian dollar strengthened by approximately 16% against the U.S. dollar compared to Q1 2009, negatively impacting reported revenues and expenses.

Guidance, Outlook, and Risks

• Capital Program: CP expects 2010 capital expenditures to range between $680 million and $730 million. This includes ~$585 million for renewals and ~$115 million for IT and efficiency projects.
• Pension Contributions: Estimated aggregate contributions for 2010 and 2011 are projected to be between $150 million and $200 million per year.
• Tax Rate: Management expects a normalized effective income tax rate (excluding FX on long-term debt) of 25% to 27% for 2010.
• Key Risks:
  • Regulatory: Implementation of Positive Train Control (PTC) in the U.S. by 2015, estimated to cost up to $250 million USD.
  • Labour: Ongoing collective bargaining negotiations with various unions in Canada and the U.S.; potential for work stoppages.
  • Market: Dependence on North American economic recovery, commodity prices (grain, coal, fertilizer), and fuel price volatility.
  • FX: Continued exposure to fluctuations between the Canadian and U.S. dollars.

Investor Verification Checklist

• FX Sensitivity: Verify the impact of the strengthening Canadian dollar on future U.S. dollar-denominated revenue and debt translation.
• Rate Decisions: Monitor the impact of Canadian Transportation Agency (CTA) rate decisions on regulated grain and coal revenues.
• Capital Expenditures: Track actual capital spending against the $680M-$730M guidance, particularly regarding PTC implementation costs.
• Pension Deficit: Review the funded status of the defined benefit pension plan and the sensitivity of the deficit to changes in discount rates and asset returns.
• Labour Negotiations: Monitor the status of collective bargaining agreements, particularly those expiring in 2010 and 2011.
• Non-GAAP Reconciliations: Review the reconciliation of "Adjusted Diluted EPS" and "Free Cash" to GAAP measures to understand the impact of FX on long-term debt and other specified items.