Canadian Pacific Railway Limited’s (CP) adjusted earnings per share of 75 Canadian cents (77 cents) per share in the second quarter of 2011 were in line with the Zacks Consensus Estimate.
However, adjusted earnings of the second-largest Canadian railway plunged 23.5% from 98 Canadian cents per share in the year-ago quarter. Earnings were adversely affected by a difficult operating environment resulting from flood conditions throughout the second quarter that led to a higher operating cost.
Revenues increased 2.5% year over year to C$1.26 billion ($1.30 billion) but were below the Zacks Consensus Estimate of $1.29 billion. The year-over-year growth was backed by a positive price mix and increased fuel surcharges that compensated for lower volumes.
On a year-over-year basis, Carloads (volumes) dropped 4.3% and revenue ton miles, which measure the relative weight and distance of rail freight transported by Canadian Pacific, fell 2.5%. Coal and Intermodal showed a major decline in volumes followed by Grain. The floods lowered train speed and disrupted train operations, resulting in restricted productivity and network capacity.
Operating income declined 15.9% year over year to C$230.5 million ($238.2 million). Operating expenses climbed 7.7% year over year primarily due to higher fuel expenses (up 33.4% year over year). Operating ratio (defined as operating expenses as a percentage of revenue) deteriorated 400 bps to 81.8% from 77.8% in the year-ago quarter.
Liquidity
Canadian Pacific exited the second quarter with cash and cash equivalents of C$267.8 million, which was much lower than C$373.6 million in the year-ago quarter. Long-term debt remained flat with first quarter at C$3.9 billion.
Guidance
Canadian Pacific projected long-term capital expenditures of C$587.1 million and operating expenditures of C$1,721.4 million for the years 2011–2028.
Our Analysis
Despite weather-related challenges, Canadian Pacific showed sequential growth in revenue, on pricing recoveries. We believe the current economy remains positive for the broader market and Canadian Pacific’s earnings will eventually rebound, supported by strong pricing. Volumes are also expected to recover from a lull in the first and second quarters as weather conditions stabilize and operations return to normal levels. In addition, long-term investments and rising coal volumes resulting from an agreement with Teck Resources Limited (TCK) are expected to yield higher profitability in future.
However, rising fuel prices, lackluster earnings, competitive threats from railroads like Canadian National Railway (CNI), a strong Canadian dollar, highly unionized workforce and regulatory pressures, increasing headcount as well as negative impacts on the automotive business due to the Japan disaster compel us to have a negative outlook on the Company.
Thus, we currently maintain our long-term Underperfrom recommendation on Canadian Pacific. However, the stock holds a short-term (1-3 months) Zacks #3 Rank (Hold).
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