CP

Business Context and Reporting Period

Company: Canadian Pacific Railway Limited (CP)
Filing Type: Form 6-K (Report of Foreign Issuer)
Reporting Period: First Quarter ended March 31, 2015
Release Date: April 21, 2015
Business Overview: CP operates a transcontinental railway in Canada and the United States, providing freight transportation services for bulk commodities, merchandise, and intermodal traffic across a network of approximately 13,700 miles.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Revenues increased 10% to a record $1.67 billion, driven by higher traffic volumes in most lines of business (grain, potash, chemicals, intermodal) and favorable foreign exchange impacts.
• Operating Efficiency: The Operating Ratio (OR) improved by 880 basis points to a record low of 63.2%. This was primarily due to efficiency savings, lower fuel expenses (down 28% due to lower prices and better efficiency), and higher land sales.
• Profitability: Net income rose 26% to $320 million. Adjusted earnings per share increased 59% to $2.26.
• Foreign Exchange Impact: A $64 million charge (after-tax $55 million) related to foreign exchange translation on U.S. dollar-denominated debt negatively impacted reported earnings. Excluding this item, underlying performance was significantly stronger.
• Share Repurchases: The company repurchased 2.17 million shares for $490 million in Q1 2015, compared to 0.57 million shares for $87 million in Q1 2014.

Guidance, Outlook, and Risks

Management Commentary and Guidance

Management expressed confidence in the company's plan and people, citing a business model that responds nimbly to economic shifts. Full-year 2015 financial expectations include:

• Revenue Growth: 7-8%.
• Operating Ratio: Below 62%.
• Adjusted EPS Growth: 25% or greater compared to 2014.
• Capital Expenditures: Approximately $1.5 billion.
• Key Assumptions: CAD/USD exchange rate of $1.20; average fuel price of US$2.70; income tax rate of 27.5%.

Risks and Contingencies

• Lac-Mégantic Litigation: CP is a defendant in class action lawsuits and administrative proceedings related to the July 2013 derailment in Lac-Mégantic, Quebec. While CP denies liability, a Plan of Arrangement in the Montreal Maine and Atlantic Railway (MM&A) bankruptcy seeks to distribute a $293 million fund. CP has not contributed to this fund and objects to the release of responsible parties.
• Regulatory Changes: Ongoing discussions regarding the transportation of hazardous commodities, including new tank car standards and potential liability caps (Bill C-52 in Canada).
• Labour Relations: Approximately 77% of the workforce is unionized. A tentative four-year settlement was reached with Unifor in Q1 2015. CP is currently in binding arbitration with the Teamsters Canada Rail Conference regarding locomotive engineers and conductors.
• Asset Sale: CP finalized an agreement to sell a portion of the Delaware and Hudson Railway line to Norfolk Southern for approximately US$215 million, subject to regulatory approval.

Investor Verification Checklist

• FX Sensitivity: Verify the impact of the CAD/USD exchange rate on future earnings, as a significant portion of debt and operations are USD-denominated.
• Adjusted vs. GAAP EPS: Confirm the reconciliation of the $0.34 per share difference between GAAP and Adjusted EPS caused by the FX translation charge on debt.
• Share Count: Monitor the reduction in outstanding shares due to the aggressive share repurchase program (NCIB) and its effect on future EPS.
• Legal Exposure: Track the status of the Lac-Mégantic litigation and the MM&A bankruptcy plan approval, as potential liabilities remain uncertain.
• Capital Discipline: Review the execution of the $1.5 billion capital program, specifically the allocation between track/roadway (70%) and rolling stock (10%).