What drove the large increase in net income in the second quarter of 2005?

Net income rose $39.5 million to $123.2 million, mainly due to higher revenue from freight rate increases, fuel surcharges, and a revenue recognition from the new EVC coal agreement. Operating income grew $50.5 million, partly offset by higher fuel, compensation, and depreciation costs.

Is the revenue growth sustainable, and how much came from one-time items?

The filing attributes about $6 million of Q2 coal revenue and about $23 million year to date to retroactive services provided to EVC in 2004, which are non-recurring. Underlying growth came from rate increases and fuel surcharges, while the company deliberately reduced low-margin, short-haul traffic as part of its quality revenue growth strategy.

How is CP managing fuel cost exposure?

CP uses fuel surcharges billed to customers and a hedging program. Hedges cover about 35% of its remaining 2005 fuel purchases, and fuel expense was reduced by $10.6 million in Q2 through realized swap gains. Management estimates each US$1 increase in WTI crude raises annual fuel expense by about $8 million before hedging.

What are the main risks flagged in the filing?

Key risks include crude oil price volatility, foreign exchange swings (a $0.01 rise in the Canadian dollar reduces annual operating income by about $3 million), upcoming labour negotiations with several unions in Canada and the U.S., an environmental remediation program at a Minnesota property with a $90.9 million charge taken in 2004, and pension funding requirements of about $300 million over 2005 and 2006.

Is the company returning capital to shareholders?

Yes. CP paid a quarterly dividend of $0.15 per share declared in May 2005 and has a normal course issuer bid to repurchase up to 2.5 million shares through June 2006. It bought 432,000 shares in Q2 at an average of $43.58, and it plans to repurchase about 2.07 million more, an estimated $90.1 million, largely offset by option exercise proceeds.

CP 8-K SEC Disclosure — Jul 26, 2005

01—Abstract

Summary

Summary of the 6-K filed July 26, 2005. Cited figures are marked; the original filing is the authoritative source.

Canadian Pacific Railway's (CP) Form 6-K furnished on July 26, 2005 contains its unaudited second-quarter and first-half 2005 results, MD&A, and supporting regulatory exhibits.

Q2 2005 net income rose to $123.2 million^a (diluted EPS $0.77) from $83.7 million ($0.53) a year earlier, and first-half net income reached $203.9 million ($1.27 diluted EPS) versus $107.2 million ($0.67). Revenue grew 10% in the quarter to $1,105.9 million, driven by higher freight rates, fuel surcharges, and a one-time-benefiting coal agreement with Elk Valley Coal Partnership (EVC) that added roughly $6 million in Q2 and $23 million year to date for 2004 services. Operating ratio improved to 75.5% from 78.0% in Q2, while fuel costs rose 35% in the quarter, partially offset by surcharges and hedging that recovered more than three-quarters of the increase.

Balance sheet and cash flow metrics strengthened. Operating cash flow was $359.3 million^b in Q2, free cash after dividends was $133.4 million, and the net-debt-to-net-debt-plus-equity ratio improved to 42.1% from 47.0%. CP repaid $250 million of 7.20% Medium Term Notes at maturity in June 2005, and cash fell to $131.7 million.

Management guided to 2005 revenue growth of 12% to 14%, operating expense growth of 8% to 10%, capital spending of $900 million to $920 million^c, and free cash of $50 million to $100 million. It also flagged risks including crude oil price volatility, labour negotiations across several unions, and an environmental remediation program in Minnesota. The filing also includes a normal course issuer bid for up to 2.5 million shares (about 1.6% of shares outstanding), with 432,000 shares repurchased in Q2 at an average of $43.58.

Interest coverage improved to 4.2 times, and PricewaterhouseCoopers issued a review letter with no material modifications identified in the interim statements. Note that the filing describes the company as Canadian Pacific Railway Limited and Canadian Pacific Railway Company, and that its figures are reported in Canadian dollars under Canadian GAAP.

02—Key points

Key Highlights

Q2 2005 net income of $123.2 million rose 47% from $83.7 million; diluted EPS was $0.77 versus $0.53 a year earlier.
First-half 2005 net income of $203.9 million nearly doubled from $107.2 million; diluted EPS was $1.27 versus $0.67.
Q2 revenue grew 10% to $1,105.9 million, led by freight rate increases, fuel surcharges, and the EVC coal agreement, despite a 3% decline in carloads.
Operating ratio improved to 75.5% in Q2 from 78.0%, and operating income rose 23% to $271.1 million.
Q2 operating cash flow of $359.3 million and free cash after dividends of $133.4 million; net debt-to-capital improved to 42.1% from 47.0%.
Fuel expense rose 35% in Q2 to $145.2 million, but surcharges and hedging recovered more than three-quarters of the increase.
2005 guidance calls for 12% to 14% revenue growth, 8% to 10% operating expense growth, and $50 million to $100 million of free cash.

03—Questions

Frequently Asked Questions

What drove the large increase in net income in the second quarter of 2005?
Net income rose $39.5 million to $123.2 million, mainly due to higher revenue from freight rate increases, fuel surcharges, and a revenue recognition from the new EVC coal agreement. Operating income grew $50.5 million, partly offset by higher fuel, compensation, and depreciation costs.
Is the revenue growth sustainable, and how much came from one-time items?
The filing attributes about $6 million of Q2 coal revenue and about $23 million year to date to retroactive services provided to EVC in 2004, which are non-recurring. Underlying growth came from rate increases and fuel surcharges, while the company deliberately reduced low-margin, short-haul traffic as part of its quality revenue growth strategy.
How is CP managing fuel cost exposure?
CP uses fuel surcharges billed to customers and a hedging program. Hedges cover about 35% of its remaining 2005 fuel purchases, and fuel expense was reduced by $10.6 million in Q2 through realized swap gains. Management estimates each US$1 increase in WTI crude raises annual fuel expense by about $8 million before hedging.
What are the main risks flagged in the filing?
Key risks include crude oil price volatility, foreign exchange swings (a $0.01 rise in the Canadian dollar reduces annual operating income by about $3 million), upcoming labour negotiations with several unions in Canada and the U.S., an environmental remediation program at a Minnesota property with a $90.9 million charge taken in 2004, and pension funding requirements of about $300 million over 2005 and 2006.
Is the company returning capital to shareholders?
Yes. CP paid a quarterly dividend of $0.15 per share declared in May 2005 and has a normal course issuer bid to repurchase up to 2.5 million shares through June 2006. It bought 432,000 shares in Q2 at an average of $43.58, and it plans to repurchase about 2.07 million more, an estimated $90.1 million, largely offset by option exercise proceeds.

04—Continue

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