DBRS Confirms Canadian Pacific Railway at BBB, Trend Remains Positive

DBRS has today confirmed the Issuer Rating of Canadian Pacific Railway Company (CP or the Company) as well as the Company’s Unsecured Debentures and Medium-Term Notes ratings at BBB with a Positive trend. The confirmation reflects the Company’s strong financial and business profiles, which have improved substantially over the last 24 months. DBRS upgraded CP to BBB from BBB (low) in June 2014, citing these improvements, and the Company’s performance has since progressed in line with expectations. The trend on the ratings remains Positive, indicating that DBRS could upgrade CP over the next six to 12 months, should the Company continue to sustain its operational efficiency and credit metrics at or above their current levels.

CP continued to perform strongly during the first six months of 2014, despite some headwinds facing the Company from the harsh winter conditions at the beginning of the year. Revenues were up by approximately 7% during the first six months of 2014 relative to the same period last year, primarily because of improved freight rates. Higher shipments and rates for Canadian grains, domestic intermodal, as well as crude shipments supported revenue increases, although shipments and revenues of international intermodal, coal, sulphur and fertilizers had negative impacts. The Company’s operating ratio (OR) has continued to improve to 67.3% for the last 12 months (LTM) ended June 30, 2014, compared with 69.9% for full year 2013. The improvements were consistent with the Company’s target of achieving a low 60% OR by the end of 2016.

The Company’s financial profile strengthened further during the first half of 2014. Improved levels of the OR and the resulting increases in earnings and cash flows from operations helped improve credit metrics to their current levels. Additionally, the Company paid down debt in the amount of approximately $154 million during the first six months of 2014, further strengthening its debt coverage credit metrics. Overall credit metrics continued to be positioned near the high end of the BBB range, and for the LTM ended June 30, 2014, DBRS-calculated adjusted debt-to-EBITDA improved to just below 2.0 times (x), while adjusted cash flow-to-debt improved to 38% compared with approximately 2.2x and 34%, respectively, for full year 2013.

The Company’s business profile has similarly improved over the 2012 to Q2 2014 period, primarily because of improved operating efficiency and cost management, particularly labour and fuel. Notable improvements included reduction in compensation expenses, operational reconfiguration, facility consolidation, as well as improvement in network fluidity. The Company has attained records in key operating metrics, as reflected in 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. The Company is expected to continuously asses its rail network as well as its real estate portfolio, with potential divestitures of non-core track or real estate in the near to mid-term.

DBRS expects full year 2014 revenue and growth to be in line with year-to-date revenue growth levels as a result of firm volume levels and additional freight rate increases. Volume growth is likely to be driven by strength in crude, grain and intermodal shipments, while other shipment categories, such as forestry and automotive, are expected to remain stable, paring the declines seen recently. The OR is expected to show additional improvement compared with 2013, as recently implemented cost initiatives are increasingly reflected in results and the stable economic environment provides further improvement opportunities from potential volume and revenue gains. CP remains focused on reaching a low 60% OR by the end of 2016, and DBRS notes that the Company has made substantial strides toward this goal over the course of the last two years. Accordingly, DBRS expects that OR improvements will continue to strengthen earnings and cash flows from operations, allowing the Company to improve beyond current levels of credit metrics. DBRS notes that CP repurchased approximately $565 million of common shares during the first half of 2014 using internally generated cash flow, and therefore not affecting the Company’s financial profile in relation to the current rating.

The trend on the ratings remains Positive, and DBRS notes that it will likely take positive rating action in the case that the Company continues to maintain its operational efficiency and credit metrics at or beyond their current levels. DBRS could revise the trend on the ratings back to Stable in the case that operating efficiency deteriorates or if material unexpected shocks in costs or volumes cause financial profile metrics to weaken.

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.