DBRS Changes Trend on Canadian Pacific Railway Ratings to Positive

DBRS has today confirmed the Issuer Rating and the Unsecured Debentures and Medium-Term Notes ratings of Canadian Pacific Railway Company (CP or the Company) at BBB (low), but has changed the trend to Positive from Stable. The ratings action reflects the Company’s further improvement in financial profile for full year 2013, meeting targets for positive rating action outlined in the Press Release on August 14, 2013. However, the Company has stated that it is reviewing its dividend and share repurchase options, which is a potential risk to the Company’s financial profile in the event that such distributions and related debt financing prove material. DBRS could raise the rating in the near term (within 12 months), once shareholder-friendly actions, if any, are deemed affordable and do not materially impact the current financial profile.

CP’s financial profile was weak through the 2011/2012 period as the Company suffered from a high operating ratio, weak earnings and elevated debt levels. The Company’s operational transformation, which began in the second half of 2012, has had the effect of improving earnings, cash flows and ultimately its credit metrics. In its last report dated August 14, 2013, DBRS noted that the Company’s financial profile has strengthened, positioning the Company’s credit metrics above the current rating. With the release of full year 2013 results on January 29, 2014, the Company’s credit metric improvement exceeded DBRS’s expectations, prompting DBRS to revise the Trend to Positive.

CP’s reconfigured operational model yielded strong improvements in productivity metrics during 2013, including train weights/lengths, car velocity and locomotive productivity. The Company also posted improvement in operating expenses for 2013, noting decreases in compensation, purchased services and equipment rent expenses. The operating ratio improved to 69.9% in 2013, compared with 77.0% in 2012. Market conditions remained favourable for full year 2013. Revenues were up 8%, with merchandise and bulk segments driving volume and revenue increases, partially offset by weaker intermodal volumes and revenues. CP benefitted from increasing shipments of grains and fertilizer, as well as from some positive momentum in industrial and consumer products, largely from crude by rail and related shipments such as frac sand. Automotive and intermodal shipments, on the other hand, were sluggish, with revenues decreasing in the low single digit ranges, reflecting the Company’s refocused efforts in these areas.

DBRS calculated adjusted debt-to-EBITDA for 2013 improved to 2.2 times (x), while adjusted debt-to-capital improved to 44%, compared with approximately 2.8x and 52%, respectively, for 2012. The Company performed better than expected and met DBRS’s target credit metrics of adjusted debt-to-EBITDA of 2.5x and adjusted debt-to-capital of 45%, as outlined in the Press Release dated August 14, 2013. The improvements came as EBITDA increased approximately 34% in 2013 compared with 2012, as a result of substantial operational improvements, cost reductions and modest revenue increases.

DBRS notes that the business profile has also shown some improvement as the Company made configuration changes to its network, yards and trains. The results have been positive, allowing the Company to attain record operating metrics, including better fluidity with faster transit times, fewer delays and outages, better energy efficiency and a lower cost structure. The growing crude by rail business has increased revenue diversification, while the planned disposal of the west-end portion of the Dakota Minnesota & Eastern railway will remove excess costs from the Company’s operating structure when materialized.

The outlook for economic environment remains favourable, boding well for modest revenue increases, while operational improvements and cost reduction initiatives will likely keep the operating ratio firm through 2014. Accordingly, DBRS could consider taking positive rating action in the case that credit metrics continue to be stable.

However, DBRS notes that the Company is reviewing its dividend and share repurchase options, a potential risk to the Company financial profile if the review proves material. DBRS cautions that it will closely monitor developments for greater than expected impacts of such shareholder actions on the balance sheet.

DBRS would raise the rating by one notch if the shareholder-friendly actions, if any, do not materially affect the Company financial profile and CP demonstrates that the current credit metrics are sustainable.

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.