DBRS Upgrades Canadian Pacific Railway to BBB (high), Trends Stable

DBRS has today upgraded 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 to BBB (high). The trends on all ratings are Stable. DBRS upgraded CP to BBB in June 5, 2014, and maintained a Positive trend on all ratings noting that it could further upgrade the Company should it maintain similar or improving levels of operational efficiency and financial metrics. The present rating action reflects our view that the Company’s performance has strengthened measurably as evidenced by the recently reported Q3 2014 results, which were above DBRS expectations. Additionally, DBRS’s view is that the rail industry fundamentals have improved, which should support favourable results in the medium term.

DBRS notes that industry conditions are expected to remain favourable and continue to support further improvement in operating results for the Company. The Company’s recent quarterly results, in DBRS’s view, highlight some positive industry developments, which we continue to expect going forward, including benefits of new technology and cost control, stronger growth expectations in areas of crude and intermodal and a modestly improved diversification of shipped goods. DBRS believes that these developments have resulted in an improvement in the overall industry risk profile from which CP should benefit in the medium term. Consequently, CP’s results will continue to be supported by these favourable industry developments, as well as Company-specific initiatives, such as further improvements to operations and the revenue growth plan, which was recently presented at the Company’s investor presentation.

The quarterly release on October 21, 2014, demonstrated improving levels of operating efficiency as indicated by the Company’s operating ratio, which declined to 62.8% for the third quarter of 2014 and to 66.5% for the last 12 months (LTM) ended September 30, 2014, compared to approximately 71.9 % for the LTM period ended September 30, 2013. Operating efficiency gains have been driven primarily by reduction in network costs, operational reconfigurations and network refocusing efforts. Revenues trended positively and were up by approximately 7% for the first nine months of 2014, relative to the same period last year. CP attained higher revenue-to-miles, as well as higher revenues per carload based on an improvement in mix as well as price. The Company’s financial profile has consequently improved as steady earnings and cash flow growth, as well as stable debt levels, helped lift the Company’s credit metrics beyond our expectations.

The Company has announced further shareholder-friendly actions and has since upsized the normal course issuer bid to re-purchase up to approximately 7.5 million common shares. DBRS views the current shareholder-friendly actions as manageable, and that the Company should be able to maintain its financial profile at levels commensurate with the current rating. DBRS notes that the LTM debt-to-EBITDA as at Q3 2014, was 1.97x, relative to the Company’s publically stated target of 2.0x to 2.5x.

The Company has recently confirmed that merger talks with CSX have ended; however, management has indicated that they are nonetheless open to the possibility of mergers. DBRS notes that a merger has not been factored into the current rating action and DBRS will therefore treat any business combinations as an event.

The outlook on the rating is stable reflecting DBRS’s view that the Company’s financial profile is to remain steady and near current levels in the near term. DBRS expects CP to remain judicious with repurchases, noting that CP’s publically stated debt-to-EBITDA target of 2.0x to 2.5x is compatible with the current rating. However, DBRS could take negative action in the case that negative unexpected events impact the Company, such as sudden regulatory shocks or changes in financial policy. DBRS could take positive rating action should further improvement is above expectations and should the Company continue to benefit from industry-related fundamentals.

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

The applicable methodologies are Rating Companies in the Railway Industry and DBRS Criteria: Financial Ratios and Accounting Treatments — Non Financial Companies, 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.

For more information on this credit or on this industry, visit www.dbrs.com or contact us at info@dbrs.com.