CP

Business Context and Reporting Period

Company: Canadian Pacific Railway Limited (CPR)

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

Reporting Period: Fiscal Year Ended December 31, 2004

Filing Date: March 7, 2005

Business Overview: CPR operates a transcontinental railway in Canada and the United States, providing rail and intermodal transportation services over approximately 13,800 miles. The company focuses on three primary business lines: bulk commodities (grain, coal, sulphur, fertilizers), intermodal traffic (containerized consumer goods), and merchandise freight (automotive, forest, and industrial products). Strategic priorities for 2004 included increasing network "fluidity," expanding co-operative arrangements with other railways (notably Norfolk Southern), and managing capacity constraints through operational efficiency rather than immediate capital expansion.

Key Financial Metrics (Year Ended Dec 31, 2004)

Note: All figures are in Canadian Dollars (CAD) unless otherwise noted. Prior year figures have been restated to conform with 2004 presentation.

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased by $242.2 million (6.6%). Freight revenues grew 7% to $3,728.8 million, driven by volume growth (6% increase in carloads) and rate improvements. This growth offset a negative foreign exchange impact of approximately $130 million due to the strengthening Canadian dollar.
• Operating Income: Operating income rose significantly by $231.0 million. This was primarily due to higher revenues and the absence of the $215.1 million restructuring charge and $28.9 million asset transfer loss recorded in 2003. These gains were partially offset by a $90.9 million special charge for environmental remediation in 2004 and increased operating costs (fuel, compensation, depreciation).
• Net Income: Net income increased modestly by $11.7 million. The increase was driven by higher operating income and a $19.0 million reversal of a prior restructuring charge. However, this was dampened by a $115.1 million decrease in foreign exchange gains on long-term debt (from $209.5 million in 2003 to $94.4 million in 2004) and the aforementioned environmental charge.
• Foreign Exchange Impact: The strengthening Canadian dollar (average rate $1.30 in 2004 vs. $1.41 in 2003) reduced reported revenues and operating income. Management estimates that a $0.01 increase in the Canadian dollar reduces annual operating income by approximately $3 million.
• Productivity: Revenue ton-miles increased 8% while train-miles increased only 2%, indicating significant gains in asset utilization and fluidity.

Guidance, Outlook, and Risks

Management Commentary and Outlook

• 2005 Revenue Guidance: Management anticipates revenue growth of 6% to 8% in 2005, assuming continued strong freight volume growth in grain, fertilizer, intermodal, and coal sectors, along with rate increases.
• 2005 Expense Outlook: Total operating expenses are expected to increase 5% to 6%. Fuel expenses are projected to rise 18% to 20% (assuming West Texas Intermediate crude oil averages US$48/barrel), while non-fuel expenses are expected to rise 3% to 4%.
• Capital Spending: Projected capital spending for 2005 is approximately $760 million, focused on track infrastructure renewal and locomotive acquisitions. A phased infrastructure expansion program (approx. $500 million total) is under consideration but contingent on regulatory stability and traffic growth.
• Free Cash Flow: Expected to generate $50 million to $100 million in free cash flow for 2005.

Risks and Contingencies

• Environmental Remediation: A $90.9 million charge was recorded in Q4 2004 for contamination at a Minnesota property. Costs are expected to be incurred over 10 years. CPR has initiated litigation against former lessees but has not accrued any recovery pending the outcome of the trial scheduled for 2007.
• Coal Dispute: CPR is in a dispute with Elk Valley Coal Corporation (EVCC) regarding rates and services. While an arbitrator ruled in CPR's favor on one matter, legal proceedings were suspended in January 2005 for mediation. The outcome could materially impact revenues.
• Foreign Exchange: Continued volatility in the CAD/USD exchange rate remains a significant risk, as a substantial portion of revenues and expenses are USD-denominated.
• Fuel Prices: Diesel prices remain volatile. CPR utilizes hedging (covering 31-33% of 2005 needs) and fuel surcharges to mitigate risk.
• Capacity Constraints: Significant increases in rail traffic have created capacity challenges, particularly on the Pacific Coast. CPR is managing this through operational improvements and potential future infrastructure investment.
• Pension Deficit: The defined benefit pension plan deficit was $604.3 million at year-end. Funding requirements are subject to market conditions and actuarial valuations.

Key Facts for Investor Verification

• Environmental Liability: Verify the status of the Minnesota property remediation and the progress of litigation against former lessees, as the $90.9 million charge may be subject to change.
• Coal Arbitration: Monitor the resolution of the dispute with Elk Valley Coal Corporation, as it involves a significant customer and could impact future coal revenues.
• Foreign Exchange Sensitivity: Assess the impact of the Canadian dollar's strength on future earnings, noting the company's use of USD-denominated debt as a natural hedge.
• Infrastructure Expansion: Track regulatory developments regarding the proposed $500 million phased expansion program west of Moose Jaw, Saskatchewan, which is contingent on government signals.
• Pension Funding: Review upcoming actuarial valuations (Jan 1, 2005 and 2006) to understand future cash flow requirements for the $604.3 million pension deficit.
• Non-GAAP Measures: Note that management emphasizes "Income before FX on LTD and other specified items" ($361.4 million in 2004) as a key performance indicator, excluding volatile foreign exchange gains on debt and one-time charges.