CP

Business Context and Reporting Period

Company: Canadian Pacific Railway Limited (CPR)

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

Reporting Period: First Quarter ended March 31, 2004

Business Overview: CPR is a transcontinental carrier operating a 14,000-mile rail network serving Canada and the U.S. Northeast and Midwest. The company reported strong operational momentum in Q1 2004, with freight volumes up 11% despite severe weather disruptions, including a major avalanche in January that impacted western corridors.

Key Financial Metrics

Non-GAAP Adjusted Metrics: Excluding foreign exchange (FX) gains/losses on long-term debt, Net Income was $38 million (EPS $0.24) in Q1 2004, compared to $37 million (EPS $0.23) in Q1 2003.

Material Changes vs. Prior Period

• Net Income Decline: GAAP net income fell 77% to $23.5 million. This was primarily driven by a $14 million after-tax FX loss on long-term debt in Q1 2004, compared to a $64 million after-tax FX gain in Q1 2003.
• Revenue Growth: Total revenues increased 0.9% to $886.6 million.
  • Bulk Commodities: Up 5% ($19 million) due to strong Pacific Rim demand.
  • Intermodal: Up 12% ($27 million) driven by port volumes and a competitor strike.
  • Merchandise: Down 10% ($27 million) largely due to the stronger Canadian dollar.
• Operating Expenses: Increased 1.3% to $770.6 million. Compensation and benefits rose 8% due to hiring for volume growth and higher pension costs. Depreciation and amortization increased 10% due to new asset investments.
• Currency Impact: The Canadian dollar appreciated 16% year-over-year against the U.S. dollar, reducing reported revenues by approximately $59 million and operating income by $13 million.

Guidance, Outlook, and Risks

• 2004 Revenue Outlook: Management expects full-year 2004 revenues to grow 4% to 6% over 2003, assuming an average exchange rate of $1.33 CAD/USD and normal grain production.
• 2004 EPS Outlook: Targeting diluted EPS growth of 5% to 10% (excluding FX on debt) over the restated 2003 adjusted EPS of $2.07. This assumes an average oil price of $33/barrel.
• Operational Response: To meet surging demand, CPR is hiring crews, increasing freight car productivity, and adding 41 high-performance locomotives in Q2 2004 and 25 more in Q4 2004.
• Capacity Constraints: Capacity is expected to remain tight in the medium term, particularly for bulk and intermodal traffic on western corridors.
• Risks and Contingencies:
  • Environmental: Investigating contamination at a U.S. property; costs could be material but are expected to be recovered from former lessees.
  • Legal: Various legal actions regarding injuries and property damage are ongoing, though management does not expect a material adverse effect.
  • Accounting Changes: Comparative figures for 2003 were restated for new asset retirement obligations and stock option expensing rules.

Investor Verification Checklist

• FX Sensitivity: Verify the impact of the Canadian dollar's strength on future quarters, as the company notes the negative FX impact is expected to ease in Q2 2004.
• Non-GAAP Reconciliation: Review the reconciliation of GAAP Net Income to Non-GAAP earnings (excluding FX on debt) to assess underlying operational performance.
• Restated Comparables: Ensure all year-over-year comparisons utilize the restated 2003 figures which account for new accounting policies on asset retirement obligations and stock-based compensation.
• Capital Commitments: Note the $499 million in multi-year capital commitments for locomotive overhauls and the $145 million in new senior secured notes issued in Q1.
• Volume vs. Rate: Analyze the divergence between rising freight volumes (up 11%) and declining revenue per revenue ton-mile (down 6.8%) to understand pricing power versus currency effects.