DBRS Changes Canadian Pacific Railway Rating Trends to Negative from Stable

DBRS Limited (DBRS) has today changed the trends for all Canadian Pacific Railway Company (CPR or the Company) ratings to Negative from Stable. The ratings concerned include CPR’s Issuer Rating, Unsecured Debentures rating and the Medium-Term Notes rating at BBB (high) and the Company’s Commercial Paper rating at R-2 (high). The trend change follows CPR’s first quarter 2016 result announcements and discussion of the Company’s medium-term financial plan.

CPR’s leverage and financial metrics, which have weakened since 2013 through a combination of substantially debt-financed share repurchases, have reached levels that are no longer supportive of its BBB (high) ratings. The views were expressed in DBRS’s press release issued on September 1, 2015, when CPR announced an expanded share repurchase program and again on January 22, 2016, when the Company released its full-year financial results. DBRS indicated that (1) it believed that CPR’s financial metrics will need to improve toward its internal targets throughout 2016 in order to maintain its ratings at current levels, (2) it would assess the Company’s intended path toward such expected improvement and (3) could consider a negative rating action in the event that such improvements become unlikely to achieve.

Having reviewed CPR’s Q1 2016 financial results, management plan and outlook, DBRS’s rating action reflects its expectation that meaningful improvement in financial metrics is unlikely to occur until at least 2017 or 2018. The expectation is based on (1) limited debt repayment possibility, given no material scheduled debt repayment until 2018, (2) continued share repurchase activities and an announced dividend increase could result in cash outlay of approximately $1.5 billion in 2016, largely financed by free cash flow and (3) expectation of weak market conditions to continue at least until the second half of 2016 or later. As a result, despite modest improvement in the last 12 months (LTM) Q1 2016 financial metrics driven largely by lower translated U.S. dollar-denominated debt amount due to a stronger Canadian dollar, DBRS expects CPR’s unadjusted debt-to-EBITDA to remain at the 2.7 times (x) to 2.8x level in 2016 and 2017 and it could go higher in the event that market conditions become more severe than expected. DBRS also notes that as there will be limited debt repayment and EBITDA or operating cash flows could be constrained by the current weak market conditions, CPR’s financial metrics could remain materially affected by the Canadian dollar to U.S. dollar exchange rate as 80% of CPR’s debt is U.S. dollar denominated. The combination of share repurchases and increased debt also resulted in CPR’s adjusted debt-to-capital weakening substantially to a weak 63% level as at March 31, 2016. As indicated in the previous press releases, DBRS has not taken into consideration the previous CPR offer to acquire Norfolk Southern Corporation as there was ample uncertainty on the outcome of this effort. Hence, CPR’s termination of the effort announced on April 11, 2016, would not have any impact on its ratings.

DBRS recognize CPR’s focus on operating efficiency and capacity management, which contributed to a record operating ratio of 60% for LTM Q1 2016, and that such focus has been and will remain instrumental and necessary for CPR to generate sustained cash flow to support its cash uses in capital expenditures and distributions. However, the current rating action reflects DBRS’s concerns over the Company’s aggressiveness in shareholder-friendly actions and volatility of its financial metrics over the past five years, which are characteristics not expected of a strong investment-grade-rated corporate.

Going forward, DBRS will assess developments in CPR’s operating and financial results, as well as its future distribution levels. DBRS could lower CPR’s ratings by one notch in the event that the Company makes limited progress toward returning its financial metrics toward its internally targeted unadjusted debt-to-EBITDA of 2.5x (or 2.7x on an operating lease adjusted basis) by the end of 2016 or earlier in the event of any further material deterioration. Conversely, DBRS could change the trend back to Stable from Negative if more substantial-than-expected progress is made toward deleveraging and a more conservative approach toward distribution to shareholders is undertaken.

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

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.

The applicable methodologies are Rating Companies in the Railway Industry (February 2016) and DBRS Criteria: Commercial Paper Liquidity Support for Non-Bank Issuers, which can be found on our website under Methodologies.

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