Business context and reporting period
Canadian Pacific Railway Limited (the registrant named in this 10-Q) reported for the quarter and six months ended June 30, 2019. The filing reports in Canadian dollars unless noted otherwise. The business is a North American freight railway; results are subject to seasonality and operating disruptions.
Financial performance
Amounts in millions of Canadian dollars, except per-share data, ratios, and where noted.
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Revenue | $1,977 | $1,750 | $3,744 | $3,412 |
| Operating income | $822 | $627 | $1,365 | $1,167 |
| Net income | $724 | $436 | $1,158 | $784 |
| Diluted EPS | $5.17 | $3.04 | $8.25 | $5.44 |
| Adjusted diluted EPS (non-GAAP) | $4.30 | $3.16 | $7.08 | $5.85 |
| Operating ratio | 58.4% | 64.2% | 63.5% | 65.8% |
| Cash from operating activities | $721 | $711 | $1,134 | $1,108 |
| Free cash (non-GAAP) | $265 | $331 | $458 | $495 |
Q2 freight revenue increased 13%, reflecting higher volumes, rates, and favorable foreign exchange; freight revenue was $1,931 million. Q2 adjusted diluted EPS rose 36%, primarily on higher operating income and fewer shares outstanding. The company declared a quarterly dividend of $0.83 per share, up from $0.65.
Balance sheet, debt, and liquidity
- At June 30, 2019, total assets were $21.933 billion, shareholders’ equity $7.157 billion, and long-term debt including current maturities $8.539 billion.
- Cash and cash equivalents were $45 million. The company had an undrawn US$1.0 billion revolving credit facility and up to $543 million available under letter-of-credit facilities. Commercial paper borrowings were US$185 million; the company reported compliance with its revolving-credit covenant.
- Adjusted net debt to adjusted EBITDA was 2.4x, compared with 2.8x a year earlier; management’s long-term target range is 2.0x–2.5x. The filing’s adjusted net debt measure includes adjustments for pension deficit, operating leases, and cash.
- Capital additions were $683 million for the first six months. Free cash declined year over year, mainly due to higher property additions and dividends.
Material changes and management commentary
- Q2 operating income increased 31% year over year and the operating ratio improved 580 basis points. Management attributed this mainly to higher volumes and rates, improved operating performance and asset utilization, fuel-price effects, and $17 million of land-sale gains.
- Six-month operating expenses rose 6%, including higher casualty and winter-weather costs from Q1, increased stock-based compensation, inflation, and foreign exchange; lower fuel costs and operating efficiencies partly offset the increases.
- Q2 operating measures improved: gross ton-miles rose 7%, train speed 5%, train weight and length 3% each, and fuel efficiency 3%. Six-month train-accident frequency increased to 1.18 from 1.10, despite improvement in the quarter.
- Adoption of the new lease standard in January 2019 materially increased reported assets and liabilities; comparative periods were not restated. The company reported no significant income-statement impact.
Outlook, unusual items, and risks
- Management expected a 2019 annualized effective tax rate of approximately 25.5%–26%. The filing provides no clear broader full-year revenue or earnings guidance.
- Reported Q2 results included an $88 million deferred tax recovery from an Alberta tax-rate change and a $37 million foreign-exchange gain on debt and lease liabilities. The six-month period included a total $82 million FX gain. These items materially lifted GAAP earnings; adjusted results exclude the tax-rate recovery and FX impact.
- Risks identified include severe weather, derailments and dangerous-goods transportation, casualty costs, labor matters, economic and commodity-demand changes, fuel and currency volatility, inflation, litigation, and environmental liabilities.
- In the Lac-Mégantic-related proceedings, the Province of Québec’s amended claim was $315 million; other proceedings include a certified class action seeking unquantified damages and additional claims. CP denies liability and is defending the cases. Management stated potential responsibility and losses could not be determined. A separate wrongful-death-trust proceeding had a trial date set for August 2020.
- Environmental remediation provisions were $79 million at quarter end, with payments expected over 10 years through 2029. Management said resolution of pending legal actions was not expected to materially adversely affect financial position or results, while acknowledging uncertainty.
Important facts for investors to verify
- Separate underlying operating growth from favorable FX effects, tax-rate benefits, land-sale gains, and share-count reductions when assessing earnings quality.
- Track the persistence of improved operating ratios and productivity against weather, casualty, and safety trends, including the higher year-to-date train-accident rate.
- Review capital spending, free-cash generation, commercial-paper use, debt maturities, and progress toward the stated leverage target.
- Monitor the outcomes and potential exposure from Lac-Mégantic litigation and environmental remediation; ultimate losses are not reliably quantifiable in this filing.
- Consider the lease-standard adoption and non-GAAP adjustments when comparing balance-sheet and performance measures across periods.