Business Context and Reporting Period
Company: Canadian Pacific Railway Limited (CP)
Filing Type: Form 6-K (Report of Foreign Issuer)
Reporting Period: Third Quarter and First Nine Months ended September 30, 2009
Context: CP reported third-quarter results amidst a global economic recession. The company fully consolidated the results of the Dakota, Minnesota & Eastern Railroad (DM&E) for the first time in 2009, whereas 2008 results were reported on an equity income basis. Management emphasized strong cost control and resource management despite significant pressure on traffic volumes.
Key Financial Metrics
| Metric (CAD Millions) | Q3 2009 | Q3 2008 | 9M 2009 | 9M 2008 |
|---|---|---|---|---|
| Total Revenues | $1,088.2 | $1,264.7 | $3,181.3 | $3,631.9 |
| Operating Expenses | $827.0 | $964.9 | $2,554.9 | $2,883.2 |
| Net Income | $195.4 | $170.7 | $415.2 | $416.1 |
| Diluted EPS (GAAP) | $1.16 | $1.10 | $2.50 | $2.68 |
| Operating Ratio | 76.0% | 76.3% | 80.3% | 79.4% |
| Cash Provided by Operating Activities | $413.1 | $279.4 | $759.7 | $621.1 |
| Cash and Cash Equivalents (End of Period) | $615.9 | $97.9 | $615.9 | $97.9 |
| Total Debt | $4,149.0 | $4,668.8 | $4,149.0 | $4,668.8 |
Material Changes vs. Prior Period
- Revenue Decline: Total revenues decreased 14% in Q3 and 12.4% year-to-date (YTD) compared to 2008. On a pro forma basis (consolidating DM&E for both periods), revenues fell 20.3% in Q3 and 18.3% YTD, driven by lower volumes in coal, forest products, and intermodal sectors.
- Cost Management: Operating expenses decreased 14.3% in Q3 and 11.4% YTD. Fuel expenses dropped significantly (51.4% in Q3, 44.8% YTD) due to lower fuel prices and volumes.
- Adjusted Earnings: While GAAP net income increased 14.5% in Q3, this was largely due to non-recurring items. On a pro forma basis excluding foreign exchange and specified items, adjusted diluted EPS decreased 28.6% in Q3 and 37.9% YTD.
- Liquidity Improvement: Cash and cash equivalents increased from $117.6 million at year-end 2008 to $615.9 million at September 30, 2009, bolstered by a $488.9 million equity offering and asset sales.
- Debt Reduction: Total debt decreased to $4.15 billion from $4.67 billion in the prior year, aided by a tender offer to repurchase debt and the equity issuance.
Guidance, Outlook, and Unusual Items
Unusual Items and Non-GAAP Adjustments
- Asset Sales: CP recorded a $79.1 million gain ($68.1 million after tax) from the sale of Windsor Station and land in Western Canada in Q3. Additionally, a $81.2 million gain ($68.7 million after tax) was recognized in the first nine months from the sale of a portion of the Detroit River Tunnel Partnership.
- Foreign Exchange: A foreign exchange loss on long-term debt of $18 million after tax impacted Q3 2009, compared to a $6 million gain in Q3 2008. This volatility is attributed to the weakening Canadian dollar and hedging strategies.
- ABCP Restructuring: CP recorded a gain of $1.6 million in Q3 2009 related to the fair value of long-term floating rate notes replacing Asset-Backed Commercial Paper (ABCP), compared to a $28.1 million impairment charge in Q3 2008.
Management Commentary and Outlook
Management stated that traffic volumes remain under pressure due to the global recession. However, the company is refining business processes to drive structural cost improvements, increasing flexibility to respond to volume changes as the economy recovers. CP issued 13.9 million common shares in February 2009 to reduce indebtedness and augment cash positions given the uncertainty of the economic recovery.
Risks and Contingencies
- Capital Metrics: The interest coverage ratio (EBIT to net interest expense) decreased to 3.2x for the twelve months ended September 30, 2009, falling below the management target of 4.0x due to lower earnings and currency impacts. The total debt to total capitalization ratio is 38.1%, within the target of no more than 50%.
- Operational Risks: Risks include changes in North American economic conditions, agricultural production risks (weather, insects), energy commodity prices, and potential labor disputes.
Investor Verification Checklist
- Pro Forma Comparability: Verify the impact of the DM&E consolidation change on year-over-year comparisons; 2008 figures are restated on a pro forma basis to allow for line-by-line comparison.
- Non-Recurring Gains: Assess the sustainability of earnings by excluding the $147.3 million in gains from asset sales (Windsor Station, land, and partnership interest) included in the first nine months of 2009.
- Currency Impact: Review the sensitivity of earnings to the Canadian/US dollar exchange rate, which caused significant volatility in foreign exchange gains/losses on long-term debt.
- Interest Coverage: Monitor the interest coverage ratio, which is currently below management targets, to ensure compliance with financial covenants as volumes recover.
- ABCP Exposure: Confirm the status and fair value of remaining long-term floating rate notes replacing the original ABCP investments, noting the credit risk downgrades mentioned in the notes.