DBRS Upgrades Canadian Pacific Railway to BBB, Trend Remains Positive

DBRS has today upgraded the Issuer Rating and the Unsecured Debentures and Medium-Term Notes ratings of Canadian Pacific Railway Company (CP or the Company) to BBB from BBB (low). The trend remains Positive. The ratings action reflects the Company’s substantially improved financial profile, which DBRS deems sustainable for the medium term. Additionally, the Company’s business profile has shown improvement to levels above the currently assigned BBB ratings and the Positive trend indicates that DBRS could upgrade CP in the near term of nine to 18 months, should the Company demonstrate capability to sustain operational efficiency, while maintaining its financial metrics similar to their current levels.

DBRS revised the trend on its ratings to Positive in January 2014 after the release of full-year results (see press release dated January 30, 2014), highlighting that the improvement in CP’s credit metrics exceeded DBRS’s expectations. DBRS noted that it could raise the rating in the near term (within 12 months) should the financial profile remain strong and should the shareholder-friendly actions be deemed affordable. Today’s upgrade reflects the Company’s continued strength in its financial profile, as well as DBRS’s expectation that the share repurchases will not have a material impact on the Company’s financial profile.

The Company’s debt coverage metrics continued to be positioned near the high end of the BBB range. For the last twelve months (LTM) ended March 31, 2014, DBRS calculated adjusted debt-to-EBITDA for LTM Q1 2014 improved to 2.2 times (x), while adjusted cash flow-to-debt improved to 33%, compared with approximately 2.8x and 25%, respectively, for 2012. The operating ratio improved to 69% for LTM Q1 2014, compared with 77.0% in 2012.

In March 2014, the Company announced its implementation of a normal course issuer bid to re-purchase up to approximately 5.3 million common shares (or 3.0 percent of the common shares) by March 2015. DBRS views the recently announced shareholder-friendly actions, which were previously uncertain and represented a potential constraint, as manageable, since they are expected to be funded with free cash flow. Additionally, DBRS expects the Company to maintain a moderate financial policy compatible with the current rating, with further projected operating ratio improvements allowing for future repurchases to be funded with free cash flow.

DBRS also notes that the business profile has improved over the 2012-2013 period due to better operating efficiency and cost management, particularly labour & fuel. Notable improvements included elimination of non-core activities, reduction in compensation expenses, yard reconfiguration, facility consolidation, focus on insourcing and locomotive rationalization, as well as improvement in intermodal service. The Company has attained records in key operating metrics, as reflected in better network fluidity with faster transit times, fewer delays and outages and better energy efficiency. Recently, the divestiture of the non-core west-end portion of the Dakota Minnesota & Eastern railway has removed excess costs from the Company’s operating structure and rail network.

In Q1 2014, the Company continued to deliver strong operating results, considering the severe winter conditions facing the transportation industry as a whole. Although revenues and costs were adversely affected and overall Company revenue expanded approximately 1%, while the operating ratio further improved to 72% from 75.8% in Q1 2013. Revenues were supported by strong pricing gains, despite soft overall volumes due to challenging weather conditions. The outlook for CP in 2014 remains favourable, as DBRS expects the operating ratio to show additional improvement compared to 2013. Further operational improvements should further reduce costs while the stable economic environment should support volume levels and pricing gains. DBRS notes that the Company has stated its intention to maintain financial profile metrics consistent with strong investment-grade levels. With the expectation of continued earnings improvement and reasonable debt levels, DBRS expects continued strength in its financial profile.

CP has recently undergone substantial changes, resulting in an improvement in its business profile. DBRS notes that the Trend on the ratings is positive and DBRS will consider taking positive rating action within nine to 18 months, should the Company show sustained business profile improvement. DBRS could consider taking the rating back to Stable trend should the Company deviate adversely from its financial policy or in the case that earnings, debt levels or share repurchases are materially outside of expectations.

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

The applicable methodology is Rating Companies in the North American Railway Industry (June 2013), 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.

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