DBRS Comments on Canadian Pacific Railway’s Year-End 2015 Debt Level and Leverage

DBRS Limited (DBRS) today notes that, based on the full-year 2015 financial results released by Canadian Pacific Railway Company (CP or the Company) on January 21, 2016, CP’s unadjusted debt-to-EBITDA ratio of 2.8 times (x) exceeded the Company’s internal target of 2.5x. The higher-than-expected leverage was largely the result of a material increase in debt (reported in Canadian dollars, but most of which is U.S.-dollar denominated) to finance its share repurchases totalling $2.8 billion and the weak Canadian dollar affecting translation of its foreign currency debt. The latter was only partly offset by the more gradual benefit of converting U.S.-dollar-based EBITDA into Canadian dollars. On a lease-adjusted basis, DBRS estimates CP’s debt-to-EBITDA to be 2.9x to 3.0x and cash flow-to-debt to be around 24%.

DBRS notes that the Company’s internal target has already been exceeded and reiterates its opinion that, while CP’s internal leverage target of 2.5x (in unadjusted debt-to-EBITDA) and corresponding financial metrics could still support the current rating, material and sustained deviation from this threshold could pressure the ratings. Such opinion was expressed in DBRS’s press release published on September 1, 2015, related to CP’s Expanded Share Repurchase Program. Consistent with this opinion, CP’s financial metrics will need to improve toward its internal targets throughout 2016 in order to maintain its ratings at the current BBB (high) and R-2 (high) levels. DBRS will assess the Company’s intended path toward such expected improvement and could consider a negative rating action in the event that such improvements become unlikely to achieve.

DBRS expects that growth in EBITDA (and operating cash flow) in 2016 could be constrained by the weak volume growth expectation, particularly in the commodity segments (including coal, crude oil, metals and potash) that accounted for approximately 30% of CP’s revenue and carload. Therefore, while noting the Company’s intention to maintain its strong investment-grade ratings, DBRS believes that the Company’s attainment of better financial metrics could materially hinge on its intention to moderate its share repurchase program (currently suspended as the Company pursues its offer to acquire Norfolk Southern Corporation or NSC) and to deploy its operating cash flows toward debt reduction.

The foregoing assessment has not taken into consideration the ongoing CP offer to acquire NSC and its implication on the Company’s financial metrics and ratings, as there remains ample uncertainty on the outcome of this effort. Based on the latest presentation by CP on December 8, 2015, the Company estimated that pro forma unadjusted debt-to-EBITDA could increase to 4.0x at the time of cash payments for the proposed acquisition. DBRS reiterates its comments published on December 9, 2015, that CP’s ratings could be placed Under Review with Negative Implications if and when an agreement for the acquisition is reached and the regulatory approval process is initiated. DBRS could also consider downgrading CP’s ratings by one or more notches if and when regulatory approval of the voting trust structure is obtained and the transaction is financed as proposed.

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.

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