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, 2007
Filing Date: July 24, 2007
CP operates a transcontinental railway in Canada and the United States, transporting bulk commodities, merchandise freight, and intermodal traffic. The second quarter of 2007 was characterized by strong global demand for bulk commodities, record freight volumes, and operational challenges including a 26-day strike by track maintenance employees and severe weather-related disruptions in the western network.
Key Financial Metrics
| Metric (CAD Millions) | Q2 2007 | Q2 2006 | YTD 2007 | YTD 2006 |
|---|---|---|---|---|
| Total Revenues | $1,215.5 | $1,131.0 | $2,331.4 | $2,241.5 |
| Freight Revenues | $1,174.1 | $1,086.4 | $2,265.0 | $2,153.6 |
| Operating Income | $307.7 | $282.6 | $537.0 | $509.4 |
| Net Income (GAAP) | $256.7 | $378.1 | $385.3 | $486.9 |
| Income (Excl. FX & Specified Items) | $174.8 | $160.7 | $297.4 | $276.8 |
| Diluted EPS (GAAP) | $1.64 | $2.37 | $2.46 | $3.05 |
| Diluted EPS (Adjusted) | $1.12 | $1.00 | $1.90 | $1.72 |
| Operating Ratio | 74.7% | 75.0% | 77.0% | 77.3% |
| Cash from Operations | $364.5 | $282.4 | $592.2 | $456.7 |
| Free Cash (Non-GAAP) | $159.6 | $87.6 | $162.6 | $31.1 |
Liquidity & Debt: Cash and cash equivalents totaled $392.1 million at June 30, 2007. Long-term debt was $3,046.6 million. The net-debt to net-debt-plus-equity ratio improved to 35.0% from 37.7% in the prior year.
Material Changes vs. Prior Period
- Revenue Growth: Freight revenue increased 8% in Q2 and 5% YTD, driven by double-digit growth in sulphur/fertilizers and coal, and strong intermodal volumes. Grain revenue improved 9% in Q2.
- Operating Expenses: Increased 7% in Q2 to $908 million. Key drivers included a 21% rise in fuel costs (due to higher refining margins) and a 29% increase in equipment rents. One-time costs associated with the 26-day track maintenance strike also impacted expenses.
- Net Income Volatility: GAAP Net Income decreased 32% in Q2 and 21% YTD compared to 2006. This decline is primarily attributed to a $176 million future income tax benefit recorded in Q2 2006 due to Canadian tax rate reductions, which was not present in 2007. Excluding these items, underlying income increased 9% in Q2 and 7% YTD.
- Foreign Exchange: CP recorded a foreign exchange gain on long-term debt of $88.6 million in Q2 2007 (vs. $52.7 million in Q2 2006) due to the strengthening Canadian dollar.
Guidance, Outlook, and Risks
2007 Outlook:
- Adjusted Diluted EPS: Expected to be in the range of $4.30 to $4.45 (up from $3.95 in 2006).
- Revenue Growth: Anticipated to be between 4% and 6%.
- Capital Investment: Projected between $885 million and $895 million.
- Free Cash: Expected to exceed $300 million after dividends.
Assumptions: Outlook assumes oil prices averaging US$65 per barrel and an average currency exchange rate of $1.10 CAD per US$1.00.
Key Risks & Contingencies:
- Labour Relations: A tentative settlement was reached with the Teamsters Canada Rail Conference (track maintenance) in June 2007, ending a 26-day strike. Negotiations continue with other bargaining units.
- Commodity Prices: Volatility in crude oil prices and refining margins remains a significant cost driver.
- Regulatory Environment: Potential impacts from Canadian legislation (Bill C-11 and C-58) regarding grain revenue caps and shipper remedies, and U.S. Surface Transportation Board reviews.
- Weather & Operations: Severe weather conditions continue to pose risks to operational fluidity and infrastructure.
Investor Verification Checklist
- Adjusted vs. GAAP Earnings: Verify the reconciliation of GAAP Net Income to Adjusted Income, specifically the exclusion of the $176 million tax benefit from 2006 and the $17 million tax benefit in 2007.
- Fuel Hedging Effectiveness: Review the impact of the Total Return Swap and crude oil swaps on fuel expense volatility given rising refining margins.
- Strike Impact Resolution: Confirm that the 26-day strike costs are fully accounted for and assess any lingering operational inefficiencies.
- Foreign Exchange Sensitivity: Monitor the impact of the strengthening Canadian dollar on U.S. dollar-denominated debt and revenues.
- Capital Expenditure Execution: Track progress against the $885-$895 million capital investment target, particularly regarding infrastructure expansion in the Alberta Industrial Heartland.