DBRS Downgrades Canadian Pacific Railway Company Ratings to BBB and R-2 (middle), Trends Stable

DBRS Limited (DBRS) has today downgraded Canadian Pacific Railway Company’s (CP or the Company) long-term ratings (which include Issuer Rating, Medium-Term Notes and Unsecured Debenture ratings) to BBB from BBB (high) and its Commercial Paper rating to R-2 (middle) from R-2 (high). The trends for all ratings are revised to Stable from Negative after the downgrade. The rating action reflects DBRS’s opinion that CP’s aggressive approach toward share repurchases has led to weaker financial metrics that no longer support its previous BBB (high) ratings, with no material improvements expected in the near future. While CP’s business risk profile has remained strong, with continued focus on cost efficiency despite challenging market conditions, DBRS opines that the Company’s shareholder-friendly actions have caused volatility in credit metrics that is not consistent with the stability and conservatism expected of a strong-BBB-rated company.

Demand conditions for the North American freight railway industry have been challenging in the past two years. Overall volume has declined due to weak commodity prices and lower export volume (in bulk and intermodal) as emerging economies slow down and the U.S. dollar strengthens. CP has further been affected by the wildfire in Northern Alberta in Q2 2016 and low Canadian grain exports. Its total carload volume declined 2.1% in 2015 and a further 6.3% year over year in the first half of 2016. Under these challenging conditions, CP has continued to focus on capacity management and efficiency, reducing total employee count by 16% since the end of 2014 while maintaining the improving trends in all operating measures. These efforts and the substantially lower fuel expenses have helped CP reduce its lower operating ratio to 60.4% in first half 2016 from 64.7% in 2014, and as a result, EBITDA has remained resilient.

CP has been aggressive in returning funds to shareholders through share repurchases and dividends. The Company has spent $6.1 billion in share repurchases and dividends since the beginning of 2014, partly financed by additional debt of $2.8 billion. CP’s debt level further expanded by the translation effect of a strong U.S. dollar, in which approximately 88% of CP’s long-term debt is denominated. With operating cash flow and earnings being stagnant, adjusted debt-to-EBITDA increased to 2.8 times (x) for the 12 months ended (LTM) June 30, 2016, from 2.2x in 2013 while adjusted cash flow-to-debt fell to 24% from 37% during the same period.

RATING DRIVERS
The Stable trend reflects DBRS’s view that, despite the rating action, CP’s business risk profile is strong for, and its financial metrics are consistent with, its current BBB ratings. Assuming that CP maintains its efficiency focus and strong operating ratio, future direction of its ratings will depend largely upon its financial policy. A more conservative share repurchase policy that allows CP to gradually deleverage and improve its financial metrics towards their 2013 levels could be positive to the ratings. Conversely, willingness to further increase its debt to support distributions to shareholders could exert further pressure to the ratings.

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.