Morningstar DBRS Upgrades Canadian Pacific Railway Company's Issuer Rating to BBB (high) from BBB, Changes Trend to Stable

DBRS Limited (Morningstar DBRS) upgraded the Issuer Rating and Unsecured Debentures of Canadian Pacific Railway Company (CP or the Company) to BBB (high) from BBB. The trends on all ratings have returned to Stable from Positive.

KEY CREDIT RATING CONSIDERATIONS
On December 12, 2023, Morningstar DBRS confirmed the Company's Issuer Rating and Unsecured Debentures rating at BBB and changed the trends to Positive from Stable. At that time, Morningstar DBRS stated that continued improvement in the Company's financial risk profile (i.e., debt-to-EBITDA leverage declining to comfortably below 3.5 times (x)), coupled with declining integration risk of the Kansas City Southern (KCS) acquisition, should support an upgrade of the ratings over the next six to 12 months. Since then, the Company has demonstrated solid operational execution, sustained earnings and cash flow growth, a significantly lower integration risk of KCS acquisition as evidenced by the rising synergy benefits and consistently lower operating ratios, and a strengthened financial risk profile with leverage moving lower to 3.2 (x) at the end of Q3 2024 from 3.6x at the end F2023. Morningstar DBRS believes this overall improvement in CP's credit risk profile is supportive of an upgrade of the Company's Issuer Rating to BBB (high) from BBB. 

The Stable trends reflect Morningstar DBRS' expectations that continuing solid operational execution in terms of the volume and price growth should support improvement in the key credit metrics over F2025. This improvement in the credit metrics should more than offset any impact from the Company's plans to restart its share repurchase program and any adverse impact of a weak Canadian Dollar on the leverage. However, these forecast improvements to the credit risk profile are balanced by the unpredictable political risks to trade, which if realized, may affect volume demand and push revenues and cash flows lower. Overall, although the financial risk profile may continue to improve, political risks may continue to weigh on any near-term positive rating action.

CREDIT RATING DRIVERS
Morningstar DBRS could change the Stable trends to Positive if political risks subside and the Company continues to reflect steady improvement in the credit metrics through a combination of strong operational execution and disciplined capital allocation policy. Morningstar DBRS could also take additional positive rating action if key credit metrics continue to improve (i.e., debt-to-EBITDA declining to 2.5 times (x) on a sustainable basis) coupled with management's commitment to maintain key credit metrics at such levels and abatement in the political risks. Conversely, if credit metrics meaningfully deteriorate for a sustained period (i.e., debt-to-EBITDA reverts to above 3.5x with a commensurate weakening of the Company's other key credit metrics) because of either weaker-than-expected operating performance, the potential negative impact of external factors and/or more aggressive financial management, the ratings could be pressured.

EARNINGS OUTLOOK
Morningstar DBRS expects the Company's earning profile to remain solid, with revenues forecast to grow above $15.5 billion in F2025 and above $16.5 billion in F2026 from $12.6 billion in F2023 and $14.5 billion in the last 12 months (LTM) ended September 30, 2024 (Q3 2024), helped by both price increases and continuing volume growth. A recovery in volumes should be helped by a recovering intermodal growth, increasing market share of the automotive volumes, growing volumes in the Energy, Chemicals, and Plastics segment, and continued strong demand for Canadian potash. Volume recovery should be complemented with price increases that should remain ahead of inflation. In line with revenue growth, EBITDA should also grow to above $7.5 billion in F2025 and easily above $8 billion in F2026 from $5.9 billion in F2023 and $6.9 billion in the LTM ended Q3 2024.

FINANCIAL OUTLOOK
Strong EBITDA should translate to solid cash flow generation with operating cash flow reaching close to $6.0 billion in F2025 and $6.5 billion in F2026 from $4.4 billion in F2023 and $5.1 billion in the LTM ended Q3 2024. As the Company continues to invest in its network, capital expenditure is set to remain high with more than $2.7 billion expected for 2025 and 2026, respectively, from $2.5 billion in F2023 and $2.8 billion in the LTM ended Q3 2024. As a result, Morningstar DBRS forecasts free cash flow net of dividends to be more than $2.2 billion in F2025 and above $2.6 billion in F2026. Morningstar DBRS expects the Company to restart share repurchases in 2025 especially as credit metrics continue to strengthen. As such, in line with Morningstar DBRS' expectations, credit metrics should moderate further, with debt-to-EBITDA declining toward 2.6x in F2025 from 3.6x in F2023 and 3.2x in Q3 2024.

CREDIT RATING RATIONALE
The credit ratings continue to reflect CP's significant credit strengths, which include a solid railroad network connecting Canada, the U.S. and Mexico, high network efficiency, including consistently improving operating efficiency of the KCS network, solid operational execution, and experienced management. The credit ratings also consider the high capital intensity of the railway industry, structural trends of sustained regulatory focus on safety and service, reasonable probability of political actions disrupting or slowing down North American trade and the consequential impact on the CP operations, probability of an economic slowdown in Canada and/or the U.S, and a mature industry with fewer growth opportunities relative to other cyclical industries.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
There were no Environmental, Social, or Governance factors that had a significant or relevant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (August 13, 2024) https://dbrs.morningstar.com/research/437781.

BUSINESS RISK ASSESSMENT (BRA) AND FINANCIAL RISK ASSESSMENT (FRA)
(A) Weighting of BRA Factors 
In the analysis of CP, the relative weighting of the BRA factors was approximately equal. 

(B) Weighting of FRA Factors 
In the analysis of CP, the relative weighting of the FRA factors was approximately equal. 

(C) Weighting of the BRA and the FRA 
In the analysis of CP, the BRA carries greater weight than the FRA. 

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

Morningstar DBRS applied the following principal methodology:

Global Methodology for Rating Companies in the Railway Industry (June 28, 2024)
https://dbrs.morningstar.com/research/435092

Morningstar DBRS credit ratings may use one or more sections of the Morningstar DBRS Global Corporate Criteria [(April 15, 2024) -https://dbrs.morningstar.com/research/431186], which covers, for example, topics such as holding companies and parent/subsidiary relationships, guarantees, recovery, and common adjustments to financial ratios.

The following methodologies have also been applied:

Morningstar DBRS Global Corporate Criteria (April 15, 2024)
https://dbrs.morningstar.com/research/431186

Morningstar DBRS Criteria: Approach to ESG Factors in Credit Ratings (August 13, 2024)
https://dbrs.morningstar.com/research/437781

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

A description of how Morningstar DBRS analyzes corporate finance transactions and how the methodologies are collectively applied can be found at: https://dbrs.morningstar.com/research/431153.

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 info-DBRS@morningstar.com.

The credit rating was not initiated at the request of the rated entity.

This is an unsolicited credit rating.

The rated entity or its related entities did participate in the credit rating process for this credit rating action.

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

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

Information regarding Morningstar DBRS credit ratings, including definitions, policies, and methodologies, is available on dbrs.morningstar.com or contact us at info-DBRS@morningstar.com.

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