DBRS Confirms Canadian Pacific Railway at BBB (low) with Stable Trend

DBRS has confirmed the Issuer Rating of Canadian Pacific Railway Company (CP or the Company), along with the ratings of its Unsecured Debentures and Medium-Term Notes, at BBB (low) with a Stable trend. The confirmation reflects the Company’s stable business profile as a strong incumbent in the North American railway industry, as well as its strengthening financial profile, underscored by improvement in credit metrics. CP continued to grow revenues and earnings in the first half of 2013 and in 2012, versus comparable prior periods. DBRS expects that the Company will continue to maintain an improving trend in its operations and a gradual strengthening of its financial profile through improved earnings and stronger cash flow generation, possibly positioning the Company above the current rating.

Revenues were approximately 9% higher during the first six months of 2013, compared to the same period in 2012, with merchandise and bulk segments driving volume and revenue increases, although partially offset by weaker intermodal volumes and revenues. The merchandise segment is continuing along a trend of growth, in line with strengthening North American economic activity, despite weaker shipment growth in the automotive segment. Crude by rail continues to be a strong driver of revenues and earnings for the Company, as some producers of crude are choosing to transport by rail due to various benefits, such as scalability, flexibility and access. The intermodal segment continues to have weaker volumes and revenues as the Company refocuses its value proposition and exits less profitable lanes. The bulk segment continues to have mostly positive developments, with grain and sulphur/fertilizers posting revenue and shipment growth, while shipments of coal declined, due to weak domestic coal and export activities in the United States.

CP continued to deliver positive results under its reconfigured operational model, with changes to the overall network, terminals and trains yielding strong improvement in productivity metrics during 2012 and year-to-date 2013, including train weights/lengths, car velocity and locomotive productivity. The Company posted improvement in operating expenses during the first half of 2013, as productivity improvements were combined with decreases in fuel and compensation expenses. It has increasingly become evident that these operational efficiencies are now taking full hold; as such, operating results for the first six months of 2013 were strong when compared to the same period last year, with EBITDA increasing approximately 28% and cash flow from operations showing a 43% increase. The operating ratio improved to 73.9%, compared to 79.3% for the first six months of 2012, although DBRS notes that some growth is attributable to a lower comparable base in 2012, due to a nine-day strike in May of 2012 that had an estimated $59 million to $69 million impact on EBITDA.

With stronger earnings and cash flow from operations at the end of Q2 2013, CP showed good improvement in coverage and leverage metrics, consistent with DBRS’s previous expectations. The operating ratio will likely further improve during the second half of 2013, as various cost initiatives and operating improvements are incorporated into the results on a full-year basis and as additional operations improvement and cost reduction initiatives are undertaken. Accordingly, DBRS expects operating ratio improvements will continue to strengthen earnings and cash flow.

In terms of revenue, DBRS expects positive revenue growth for the overall Company in 2013, with stable revenue growth in the bulk segment due to shipments of grains and fertilizer, as well as some positive momentum in merchandise, in large part due to crude by rail shipments. Coal and intermodal shipments, on the other hand, are expected to be sluggish, in line with year-to-date trends, although these developments will be more than offset by growth in other segments. On the whole, DBRS is projecting high-single-digit revenue growth, driven by mix and price, as well as EBITDA growth in line with growth rates for the first six months of 2013.

With a generally stable revenue outlook on the back of strengthening economic activity, negative rating action is unlikely in the medium term, and with potential improvement in credit metrics for full-year 2013, DBRS could consider taking positive rating action in the case that credit metrics continue to strengthen, such that adjusted debt-to-EBITDA stays below 2.5x, and adjusted debt-to-capital is below 45%.

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

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

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.