DBRS Morningstar Confirms Ratings on Canadian Pacific Railway Company at BBB (high) and R-2 (high), Stable Trends

DBRS Limited (DBRS Morningstar) confirmed the Issuer Rating, Medium-Term Notes rating, and Unsecured Debentures rating of Canadian Pacific Railway Company (CP or the Company) at BBB (high) as well as its Commercial Paper rating at R-2 (high). All trends are Stable. The rating confirmations reflect the Company’s solid operating performance and efficiency across its network despite the Coronavirus Disease (COVID-19)-related disruptions that affected the Company since the end of the first quarter of 2020. The confirmations also reflect the Company’s commitment to a balanced financial policy that favours funding share repurchases with internally generated cash flows, resulting in leverage and operating metrics that DBRS Morningstar considers sustainable and commensurate with the ratings going forward. While CP’s growth in 2019 had somewhat slowed down, the coronavirus has significantly affected some of CP’s key markets in 2020. While the overall shipment volumes and revenues were mostly affected during Q2 2020, they have significantly recovered since then. CP is well positioned to adequately address the overall slight decline in shipments in 2020 owing to the efficiency of its network and operations and some of the cost reduction measures undertaken to address the far-reaching effects of the pandemic.

In the last 12 months ended September 30, 2020 (LTM 2020), CP’s revenue-ton-miles (RTMs) declined around 2.2% compared with F2019, following minimal change in 2019 and strong growth in both 2018 and 2017. Shipments and volume growth slowed down in 2019 because parts of the North American economy had softened as the negative repercussions of trade tensions had begun to show and other exogenous and industry-specific factors appeared. The first quarter of 2020 was strong, and there was a rebound in shipments and volume. However, due to the pandemic, the second and third quarters of 2020 saw shipments and volumes decline significantly year over year, although the third quarter performance was sequentially better than the second quarter’s. While the sales of some commodities and goods such as coal, automotive, energy and chemicals have been negatively affected by the pandemic, the sales of grain, potash, sulphur, and fertilizers were particularly strong in LTM 2020. CP’s network and fleet were adequately prepared as operating efficiency has been strong throughout 2019 and 2020 so far. In particular, the grain and potash segments’ RTMs grew by 8% and 4%, respectively, in LTM 2020 compared with F2019. The strength in the grain segment was supported by a strong crop year in Canada, while the strength in the potash segment was driven by increasing demand for food supply both domestically and globally.

CP purchased Central Maine and Quebec Railway (CMQ) in December 2019 for $174 million. CMQ will provide CP access to the ports that are further east: Searsport, Maine, and Saint John, New Brunswick. The acquisition should benefit CP’s forest products and intermodal segments and generate both additional revenue and cost synergies. However, due to the small size of CMQ relative to the overall scale of CP, the impact on CP’s credit metrics is minimal. In October 2020, CP entered into an agreement to acquire the remaining 83.5% stake in the Detroit River Tunnel Partnership from OMERS Infrastructure Management Inc. for approximately $410 million. The transaction is expected to close in the fourth quarter of 2020, subject to regulatory approvals. CP has operated the 2.6-kilometre cross-border tunnel, which links Windsor, Ontario, and Detroit, throughout the partnership period. Once CP gains full ownership of the tunnel, it should be able to rationalize the operating costs.

The Company is committed to annual capital investments of about $1.6 billion in 2020, and DBRS Morningstar expects the same level of commitment in 2021. These investments include high-capacity grain hoppers as well as other network improvements and fleet modernizations that, in DBRS Morningstar’s understanding, will continue to increase CP’s capacity and network efficiency. As a consequence and combined with the continuation of a balanced financial policy, credit metrics are expected to stay within a range that is commensurate with the current ratings with debt-to-EBITDA below 2.5 times (x) and cash flow-to-debt at around 30% in 2020 and 2021. The Company’s commitment to a strong balance sheet gives DBRS Morningstar comfort that CP will not take actions that will disproportionally favour equityholders over debtholders (i.e., increasing the funding of share repurchases through debt-issuance, such that it negatively affects the leverage ratio).

The Stable trends indicate that the ratings are currently well positioned. However, an erosion in leverage caused by weaker earnings and/or higher debt to fund shareholder distributions, such that cash flow-to-debt declines below 30% and debt-to-EBITDA increases above 2.5x on a sustained basis, could lead to a negative rating action. Conversely, positive rating pressure could arise if cash flow-to-debt increased above 35% and debt-to-EBITDA trended below 2.0x on a sustained basis.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

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

The principal methodologies are Rating Companies in the Railway Industry (January 24, 2020), DBRS Morningstar Criteria: Commercial Paper Liquidity Support for Nonbank Issuers (March 10, 2020) and Rating corporate Holding Companies and Parent/Subsidiary Rating Relationships (November 2, 2020) which can be found on dbrsmorningstar.com under Methodologies & Criteria.

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

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 under Related Documents or by contacting us at [email protected].

The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar did not have access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar trends and ratings are under regular surveillance.

For more information on this credit or on this industry, visit www.dbrsmorningstar.com or contact us at [email protected].

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