Canadian Pacific Railway Limited — Q3 2019 Form 10-Q
Reporting period: Three and nine months ended September 30, 2019. The filing is by Canadian Pacific Railway Limited (CP); the supplied company metadata names Canadian Pacific Kansas City Ltd. Financial amounts are in Canadian dollars unless noted.
Financial performance
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Revenue | $1.979B | $1.898B | $5.723B | $5.310B |
| Operating income | $869M | $790M | $2.234B | $1.957B |
| Net income | $618M | $622M | $1.776B | $1.406B |
| Diluted EPS | $4.46 | $4.35 | $12.70 | $9.78 |
| Operating ratio | 56.1% | 58.3% | 61.0% | 63.1% |
| Cash from operations | $823M | $673M | $1.957B | $1.781B |
| Free cash (non-GAAP) | $363M | $245M | $821M | $740M |
Q3 revenue rose 4% and operating income rose 10%; diluted EPS increased 3%, while net income slipped 1%. Adjusted diluted EPS (non-GAAP) was $4.61, up 12%. For the nine months, revenue increased 8%, operating income 14%, net income 26%, and adjusted diluted EPS 17%. Management attributes operating improvement principally to higher freight rates, productivity and, in the first nine months, higher volumes; quarterly EPS also benefited from share repurchases.
Q3 freight revenue increased 4% despite a 1% decline in revenue ton-miles, reflecting higher rates and mix. Energy, chemicals and plastics revenue rose 13% year over year in Q3; Potash revenue fell 10%, mainly on lower export volumes. The operating ratio improved 220 basis points in Q3, but cost inflation, lower volumes and higher depreciation partly offset revenue and fuel-cost benefits.
Cash, debt and liquidity
- At September 30, cash was $145M, total debt including current maturities was $8.983B, and shareholders’ equity was $7.215B. Debt increased from $8.696B at December 31, 2018.
- Nine-month property additions were $1.147B. The company reported positive free cash of $821M, a non-GAAP measure that it defines as operating cash flow less investing cash use, with specified adjustments.
- Liquidity included a fully undrawn US$1.3B revolving credit facility and $239M available under letter-of-credit facilities. Commercial paper borrowings were US$455M ($603M Canadian), with a weighted-average rate of 2.38%.
- CP issued $400M of 3.15% ten-year notes in Q1 and repaid US$350M of notes at maturity in Q2. Adjusted net debt to adjusted EBITDA was 2.4x, versus 2.5x a year earlier; management’s long-term target is 2.0x–2.5x.
Material changes and unusual items
- Q3 results included a $25M foreign-exchange translation loss on debt and lease liabilities, compared with a $38M gain on debt in Q3 2018. This helped drive the slight year-over-year decline in reported net income; adjusted results exclude these translation effects.
- Nine-month results included an $88M deferred tax recovery from Alberta’s enacted tax-rate reduction. The comparable 2018 period included a $21M tax recovery from Iowa and Missouri rate changes.
- CP repurchased 3.18M shares for $952M in the first nine months, including 1.52M shares for $471M in Q3. The quarterly dividend was raised to $0.83 per share from $0.65.
- CP adopted the new lease standard in January 2019. Adoption materially increased recognized lease assets and liabilities on the balance sheet but did not significantly affect the income statement. At quarter-end, operating lease liabilities were $370M and finance lease liabilities $155M.
- Severe winter conditions and more frequent and severe casualty incidents in Q1 increased costs and caused lost or deferred revenue. A $10M dispute-settlement charge was included in nine-month purchased services and other.
Outlook, risks and contingencies
For 2019, management expected low-single-digit revenue ton-mile growth, double-digit adjusted diluted EPS growth from the 2018 base of $14.51, and approximately $1.6B of capital investment. The volume outlook was reduced from mid-single-digit growth, citing delays in the Canadian grain harvest and export potash volumes and broader macroeconomic softness. Assumptions included a US$/C$ rate of approximately 1.30, an annualized effective tax rate of approximately 25.5%, no material land sales, and a roughly $9M increase in other components of net periodic benefit recovery versus 2018. Adjusted EPS is non-GAAP; the filing says a forward-looking GAAP reconciliation is impracticable because of unknown future items.
Management cited exposure to economic and commodity demand changes, weather and operating disruptions, fuel and currency movements, inflation, labour, regulation, cybersecurity, and derailment and dangerous-goods liabilities. The Lac-Mégantic proceedings include a Quebec government claim reduced to $315M, a class action seeking unquantified damages, and other claims. CP denies liability and is defending the cases; management said potential responsibility and losses could not then be determined. A consolidated liability trial was scheduled for September 2020. Environmental remediation provisions were $80M, with expected payments through 2029; additional future costs could not be quantified.
Investor verification priorities
- Confirm the legal entity and reporting history relevant to the supplied Canadian Pacific Kansas City Ltd metadata; this 2019 filing names Canadian Pacific Railway Limited.
- Assess how much earnings growth reflects recurring operating performance versus foreign-exchange and tax items, and review the company’s non-GAAP reconciliations.
- Track execution against the reduced volume outlook, double-digit adjusted EPS-growth target and approximately $1.6B capital plan.
- Review share-repurchase pace, commercial-paper funding, debt maturities and the 2.4x adjusted leverage measure.
- Monitor the Lac-Mégantic litigation, environmental obligations and weather- or casualty-related operating costs.