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 and Six Months ended June 30, 2010

Filing Date: July 28, 2010

Accounting Basis: U.S. GAAP (adopted January 1, 2010; prior periods restated)

CP operates a transcontinental railway in Canada and the United States, transporting bulk commodities, merchandise freight, and intermodal traffic. The company reported a strong recovery in volumes and financial performance compared to the recessionary environment of 2009, though operations were impacted by significant flooding in Southern Saskatchewan and Alberta in June 2010.

Key Financial Metrics

Note: Debt figures represent long-term debt, long-term debt maturing within one year, and short-term borrowing.

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 20% in Q2 and 12.1% YTD, driven by higher traffic volumes (carloads up 19.9% in Q2) and fuel surcharge recoveries. This growth was partially offset by a stronger Canadian dollar (unfavorable FX impact of ~$60M in Q2).
• Profitability: Operating income rose 48% in Q2 and 50% YTD. The operating ratio improved by 430 basis points in Q2 to 77.8%, reflecting volume leverage and cost management.
• Non-GAAP Adjusted Earnings: Adjusted diluted EPS (excluding FX on long-term debt and other specified items) increased 96% to $0.92 in Q2. This metric excludes a $68.7M after-tax gain from the sale of a partnership interest in Q2 2009.
• Expense Drivers: Fuel expenses increased 51% in Q2 due to higher prices and volumes. Compensation and benefits rose 7.8% due to higher wage rates and pension expenses. Detour costs associated with flooding increased purchased services expenses.
• Balance Sheet: Cash and cash equivalents decreased to $373.6M from $679.1M at year-end 2009, primarily due to debt repayments and significant pension plan contributions ($159.7M in Q2).

Guidance, Outlook, and Risks

• Capital Expenditures: CP updated its 2010 capital spending outlook to a range of $750 million to $800 million (previously $680M-$730M) to capture growth and productivity opportunities.
• Pension Contributions: Estimated aggregate pension contributions for 2010 are $185 million to $195 million. The company prepaid a portion of 2010 requirements in Q2.
• Operational Disruption: Severe flooding in June 2010 caused an 11-day outage of the southern mainline, reducing Q2 earnings by approximately 12 cents per share. Management expects to recover approximately half of the lost shipments in Q3.
• Key Risks:
  • Foreign Exchange: Continued volatility in the CAD/USD exchange rate impacts reported revenues and expenses.
  • Regulatory: Implementation of Positive Train Control (PTC) in the U.S. by 2015 is estimated to cost up to $250 million.
  • Labour Relations: Approximately 78% of the workforce is unionized; several collective agreements are under renegotiation.
  • Commodity Markets: Volumes are sensitive to global steel production (coal), agricultural yields (grain), and North American consumer spending (intermodal/merchandise).

Investor Verification Checklist

• Adjusted Earnings Reconciliation: Verify the reconciliation of GAAP Net Income to "Adjusted Earnings" (excluding FX on long-term debt and one-time items) to understand core operational performance.
• Flooding Impact Quantification: Confirm the specific revenue and expense impacts of the June 2010 flooding and the timeline for recovery in Q3.
• Pension Funding Status: Review the sensitivity of the pension deficit to changes in discount rates and asset returns, given the significant cash outflows for contributions.
• FX Sensitivity: Assess the impact of the strengthening Canadian dollar on future U.S. dollar-denominated revenues and debt obligations.
• Capital Program Execution: Monitor the execution of the increased $750M-$800M capital program and its impact on future depreciation and cash flow.