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 First Half ended June 30, 2008
Release Date: July 22, 2008
CP reported second-quarter results impacted by unprecedented fuel price increases, a North American economic downturn, and prolonged flooding on its U.S. mainline. Management noted that while freight revenues increased slightly due to pricing and fuel recoveries, traffic volumes declined across several key commodities.
Key Financial Metrics
| Metric | Q2 2008 | Q2 2007 | YTD 2008 | YTD 2007 |
|---|---|---|---|---|
| Total Revenues | $1,220.3 million | $1,215.5 million | $2,367.2 million | $2,331.4 million |
| Net Income | $154.9 million | $256.7 million | $245.7 million | $385.3 million |
| Diluted EPS | $1.00 | $1.64 | $1.59 | $2.46 |
| Adjusted Diluted EPS (Excl. FX & Specified Items) |
$0.97 | $1.12 | $1.72 | $1.90 |
| Operating Ratio | 79.4% | 74.7% | 81.0% | 77.0% |
| Operating Expenses | $969.2 million | $907.8 million | $1,917.9 million | $1,794.4 million |
| Cash & Equivalents (Balance Sheet) |
$80.9 million | $378.1 million | $80.9 million | $392.1 million |
| Long-Term Debt (Balance Sheet) |
$4,016.8 million | $4,146.2 million | $4,016.8 million | $4,146.2 million |
Material Changes vs. Prior Period
- Profitability Decline: Net income decreased 40% in Q2 and 36% YTD compared to 2007. Adjusted diluted EPS fell 13.4% in Q2 and 9.5% YTD.
- Revenue vs. Volume: Freight revenues increased 1.6% in Q2 and 2.3% YTD despite a decrease in traffic volume (Revenue Ton-Miles down 3.1% in Q2). This was driven by pricing and fuel surcharges.
- Cost Pressures: Operating expenses rose 6.8% in Q2 and 6.9% YTD. Fuel costs specifically increased 34.4% in both periods. Compensation and benefits expenses decreased slightly (4.3% in Q2).
- Foreign Exchange Impact: Q2 2008 included a foreign exchange gain on long-term debt of $6.8 million, compared to a gain of $88.6 million in Q2 2007. YTD 2008 showed a loss of $9.5 million versus a gain of $97.2 million in 2007.
- ABCP Impairment: In Q1 2008, CP recorded a $21.3 million charge (pre-tax) related to the change in estimated fair value of Canadian third-party Asset-Backed Commercial Paper (ABCP) investments. No additional charges were recorded in Q2.
Guidance, Outlook, and Risks
2008 Outlook Revision
Management updated its full-year guidance to reflect higher fuel assumptions and deteriorating economic conditions:
- Adjusted Diluted EPS: Revised to $4.00 – $4.20 (previously $4.40 – $4.60).
- Total Revenue Growth: Expected to increase 6% – 8% (previously 4% – 6%), driven by fuel recovery.
- Operating Expenses: Expected to increase 11% – 13% (previously 6% – 8%) due to higher fuel costs.
- Free Cash Flow: Revised down to approximately $150 million (previously $200 million).
- Fuel Assumptions: Crude oil expected to average US$121/barrel (previously US$98); all-in fuel price expected between US$3.80 and $3.90 per gallon.
Risks and Contingencies
- ABCP Restructuring: CP holds approximately $144 million in original cost ABCP investments. The estimated fair value as of June 30, 2008, was $100.8 million. Continued uncertainties regarding the restructuring process and underlying asset values could lead to further material changes in investment value.
- Regulatory: The Canadian Transportation Agency directed a downward adjustment of maximum revenue entitlement for regulated grain. CP has applied to appeal; the retroactive component is estimated at $23 million, for which no provision has been made as it is not considered legally supportable.
- Operational: Risks include severe weather (flooding), fuel price volatility, and North American economic slowdown.
Investor Verification Checklist
- ABCP Valuation: Verify the status of the ABCP restructuring and potential for further impairment charges beyond the $21.3 million already recorded.
- Fuel Recovery Effectiveness: Monitor the ability to pass through fuel cost increases to customers via surcharges and pricing, given the lag in regulatory adjustments.
- Volume Trends: Assess the sustainability of revenue growth given the decline in traffic volumes (RTMs) in key sectors like forest products and grain.
- Liquidity Position: Review the significant decrease in cash and cash equivalents (from $378.1M to $80.9M) and the utilization of the $945 million revolving credit facility.
- Grain Revenue Entitlement: Track the outcome of the appeal regarding the Canadian Transportation Agency's decision on grain revenue caps.