CP

Business Context and Reporting Period

Company: Canadian Pacific Railway Limited (CPR)

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

Reporting Period: Third quarter and nine months ended September 30, 2005

Filing Date: October 25, 2005

CPR is a transcontinental carrier operating a 14,000-mile rail network serving Canada and the U.S. Northeast and Midwest. The company reported solid earnings results driven by a "quality revenue growth strategy," which focuses on higher-margin traffic, and the successful execution of a western capacity expansion project nearing completion.

Key Financial Metrics

Note: Balance sheet figures are as of September 30, 2005, compared to December 31, 2004 where applicable.

Material Changes vs. Prior Period

• Revenue Growth: Revenue increased 11.6% year-to-date, driven by a 12% increase in freight revenue per carload. Coal revenue surged 42% in Q3 due to higher rates and a retroactive agreement with Elk Valley Coal Partnership (EVC). Intermodal revenue grew 13% in Q3.
• Profitability: Net income rose 15% in Q3 and 44% year-to-date. Excluding foreign exchange gains on debt and other specified items, diluted EPS grew 29% in Q3 to $0.84.
• Operating Efficiency: The operating ratio improved by 50 basis points in Q3 and 240 basis points year-to-date, reflecting better yield management despite higher costs.
• Cost Pressures: Operating expenses increased due to record fuel prices and higher compensation costs. Fuel expenses rose 30% in Q3, though surcharges and hedging recovered almost all of the increase. Compensation costs were elevated due to stock-based incentives tied to a rising share price.
• Unusual Items:
  • Foreign Exchange: A $65.4 million gain on long-term debt in Q3 (due to a stronger Canadian dollar) boosted net income. Year-to-date gain was $45.3 million.
  • Environmental Remediation: A $33.9 million reduction in a special charge was recorded in Q3 following a settlement regarding environmental contamination at a U.S. property.

Guidance, Outlook, and Risks

• Full-Year 2005 Outlook:
  • Revenue: Expected to increase 12% to 14%.
  • Diluted EPS (Adjusted): Expected to be in the range of $3.15 to $3.25 (excluding FX on debt and specified items).
  • Assumptions: Outlook assumes oil prices averaging US$55/barrel and an exchange rate of $1.23 CAD/USD.
• Capital Expenditures: Projected at $900 million to $920 million for 2005, primarily for track expansion in the Western Corridor.
• Key Risks and Contingencies:
  • Fuel Prices: Continued volatility in crude oil prices, though mitigated by surcharges and hedging (34% of remaining 2005 purchases hedged).
  • Labour Relations: Ongoing negotiations with various unions; arbitration expected for Teamsters (locomotive engineers) in late 2005. No disruptions anticipated.
  • Foreign Exchange: A stronger Canadian dollar negatively impacts reported revenues and expenses denominated in USD.
  • Environmental: Remaining liability accruals for remediation work not covered by the recent settlement.

Investor Verification Checklist

• Adjusted EPS vs. GAAP EPS: Verify the impact of the $65.4 million foreign exchange gain on long-term debt on Q3 net income, as this is a non-cash, unrealized gain.
• Coal Revenue Sustainability: Confirm the terms of the EVC agreement and whether the retroactive revenue recognized in 2005 will recur in future periods.
• Fuel Hedging Effectiveness: Review the extent of fuel price recovery through surcharges and the remaining exposure to oil price volatility for the fourth quarter.
• Capital Spending Execution: Monitor the completion of the Western Corridor expansion and its impact on future operating efficiency and capacity.
• Share Repurchases: Note the company's active share buyback program (1.76 million shares repurchased YTD) and its impact on diluted share count.