Investors unfazed by falling cash flows at Canadian Pacific

Canadian Pacific’s (CP) second-quarter results were slightly worse than expected and confirmed broader trends in the railroad industry.

Its quarterly performance was similar to that of CSX, which reported interim results one week earlier. However, canny investors boosted CP’s share price, which has now surged almost 18% since the turn of the year, despite industry headwinds and a failed attempt to acquire Norfolk Southern.

Based on multiples for core cash flows and earnings, CP stock may have further to run, particularly if its yield continues to be nicely covered by earnings.

The Calgary-based group said on July 20 that “revenue challenges in the quarter included lower-than-anticipated bulk volumes, devastating wildfires in northern Alberta and a strengthening Canadian dollar”.

While it responded by adapting its cost structure “as quickly as possible” to the unfavourable trading conditions, it was not able to fully mitigate “the precipitous volume decline”.

Quarterly revenues fell 12% to C$1.45bn from C$1.65bn, with operating income was down 14.7% to C$551m from C$646m one year earlier, which led to a rise in the operating ratio, up 110 basis points to 62% from 60.9% – in contrast, the operating ratio was two percentage points lower at 58.9% in the first quarter.

The fall in operating expenses, down 11.5% to C$899m year-on-year, did not fully offset the drop in reported revenues, although fuel costs dropped the most (-29%) year-on-year, followed by materials (-16%), purchased services (-13%), and compensation and benefits (-8%).

Quarter-on-quarter trends also signalled a marked deterioration in many of its key financial metrics, with sales, for example, falling at much faster pace year-on-year than in the first quarter.

The rise in revenues from forest products (+15%), fertilizers (+9%) and automotive (+2%) was only mildly encouraging, given the massive drop in sales from the worst-performing sectors, which are crude (-70%), potash (-25%), Canadian grain (21%), metals & minerals and consumer products (-13%), and coal (-11%).

Meanwhile, domestic intermodal activities and international intermodal operations shrank 8% and 10%, respectively.

Freight revenues per RTM followed a similar pattern, while other metrics were also weak, although guidance for potash and grain activities was more encouraging for the remainder of the year.

As a result, reported net earnings declined 16% to C$328m, while adjusted income dropped 23% to C$312m. A lower share count mitigated the drop in earnings per share, down 9% to C$2.15 in the second quarter. 

However, dividends are still rising, up 42% and 21%, respectively, in the second quarter and in the first half of the year on a comparable basis.

The payout ratio looks safe, but cash flows are under pressure and net debt is rising due to a rapidly falling cash pile, which plunged to C$92m from C$650m in the first six months of the year.

In fact, while cash flow from investing was stable year-on-year at C$539m in the first half of 2016, cash flow from operations fell to C$730m from C$1.14bn, and cash outflows from financing rose by almost C$100m to C$731m.

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Source: Transport Intelligence, July 27, 2016

Author: Alessandro Pasetti