DBRS Places CP Under Review with Negative Implications following New Notes Issuances

DBRS has today placed the BBB Medium-Term Notes and Unsecured Debentures ratings of Canadian Pacific Railway Company (CP or the Company) Under Review with Negative Implications, following the announcement that the Company plans to issue up to US$500 million in senior unsecured notes in the United States. The issue will include ten-year and 30-year tranches. DBRS understands that CP intends to use the proceeds to fund a voluntary prepayment to its Canadian defined-benefit pension plans in 2011. In addition, CP intends to access debt markets other than the U.S. public market to raise additional debt for the same purpose. Any additional debt offerings will depend on capital market conditions and may occur in the near future. This rating action follows DBRS’s recent trend change to Negative on CP’s ratings (see press release dated November 16, 2011, for additional details).

The increase in debt levels, coupled with weaker-than-expected operating results in the first nine months of 2011, will result in a financial profile that is no longer commensurate with the BBB rating. On a proforma basis for the rolling 12 months to September 30, 2011, DBRS expects debt-to-EBITDA to increase to 3.6 times and cash flow-to-total debt to stand at 0.20 times. Even though we expect better operating results in Q4 2011, the metrics will not be significantly different; that is, they will still be weak for the BBB rating. DBRS will likely downgrade CP’s rating by one notch to BBB (low), with a Stable trend, once the transaction is completed as planned.

Since DBRS last confirmed the ratings at BBB in November 2010, CP has not met DBRS’s expectations of an improved financial profile. The November 22, 2010, DBRS press release indicated that “over the next 12 months, DBRS expects the Company’s financial profile to reflect metrics that are more in line with the current rating.” Severe winter weather and subsequent flooding conditions led to poor operating results in the first nine months of 2011. This, coupled with higher debt, has led to a deterioration in the Company’s credit metrics to below the BBB rating range.

In the near term, DBRS does expect the Company to show modest improvement in operating results and debt coverage ratios. However, CP’s financial profile will likely remain at the BBB (low) range despite this improvement, as the Company could face headwinds to stage a meaningful recovery in its operating results as a result of: (1) a slowing global economy, (2) strong competition to recover its reduced market share in intermodal traffic, and (3) possible recurrence of inclement weather conditions, similar to those experienced in H1 2011. The North American and global economy have seen signs of slowdown, which could put pressure on future volumes and dampen earnings and cash flow, offsetting the potential benefit of price increases and efficiency measures. DBRS does note that CP’s business risk profile remains relatively unchanged compared with the prior year.

The issuance will increase debt levels, which were previously expected to decrease following the cash redemption of $100 million in term debt maturing in May 2013 and the tendered $250 million note due in October 2011. The voluntary contribution follows the $500 million and $650 million contributions to CP’s Canadian defined-benefit pension plan made in late 2009 and in September 2010, respectively. It should be noted that DBRS does not consider underfunded pension liabilities as debt. We do acknowledge the positive benefits that will result from the aforementioned contribution in the form of lower cash pension payments going forward.

The notes will be unsecured obligations and rank pari passu with all of CP’s existing and future unsecured and unsubordinated indebtedness. The U.S. debt offering is being made in the United States under the base shelf prospectus dated June 29, 2011, which allows for offerings of up to US$1.5 billion of debt securities and is pursuant to the Company’s May 8, 2007, trust indenture. The interest rates, maturity dates and net proceeds of the U.S. offerings have not yet been determined.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The applicable methodology is Rating Companies in the North American Railway Industry, which can be found on our website under Methodologies.