DBRS Confirms CP Railway’s Long-Term Ratings at BBB

DBRS has today confirmed the long-term debt ratings of Canadian Pacific Railway Company (CP or the Company) at BBB with a Stable trend reflecting the Company’s improvement in operating performance during 2010 compared to 2009 where CP was adversely impacted by the economic recession. While near-term uncertainty remains with respect to the pace of economic recovery, rail fundamentals remain reasonable and as such, DBRS expects that CP should to generate solid operating results and generate free cash flows. In addition, the Company remains committed to a strong balance sheet and thus DBRS expects that free cash flows will be used for debt reduction. While financial metrics are still weak for the rating, it is expected that the Company’s operating performance will improve in 2011 resulting in a financial profile that will be more in line with a BBB rating.

CP’s operating results started to recover in 2010 from bottom of the cycle levels experienced in 2009 (due to the global recessionary conditions). Higher 2010 volumes in most business segments in particular fertilizer, as well as higher base prices and efficiency gains are largely responsible. Stronger results were partially offset by the strengthening of the Canadian dollar against the U.S. dollar.

The Company generated strong free cash flows before working capital over the past nine months to September 30, 2010, compared to full year break-even levels in 2009 with stronger earnings being the main driver. The Company continued to demonstrate its commitment to strengthening the balance sheet by using its free cash flows to reduce debt overall levels at the end of Q2 2010.

In September 2010, the Company used proceeds from a debt issuance combined with cash on hand, toward a $650 million voluntary pension contribution which followed the $500 million contribution to CP’s pension plan announced in late 2009. While the above voluntary pension prepayments reduces CP’s liquidity position. DBRS acknowledges the positive benefits resulting from lower cash pension payments going forward. Despite such large contributions, the Company’s liquidity remains strong with over $1 billion (in cash and cash equivalents and available credit lines) at the end of Q3, 2010 which is sufficient to cover upcoming 2011 maturities. Despite improved earnings and overall lower debt levels at the end of Q3 2010, CP’s financial metrics are still at the low end of the rating range for the BBB rating.

Going forward, DBRS expects further growth in earnings in the near term and into 2011. Driving the improvement are expected modest increases in overall volumes, further freight rate increases and ongoing operational efficiencies. While the economic outlook remains uncertain, the risk of a sharp volume decline over the near term is viewed as unlikely. Volume growth is supported by an improved domestic demand environment and Asian trade growth. In addition, CP has locked in roughly two-thirds of its book of business for 2011, which provides support to the Company’s financial risk profile. However, expected ongoing strength of the Canadian dollar will continue to pressure margins.

In line with earnings, cash flows (before working capital) are expected to improve in the near term and stabilize in 2011 due to higher expected capex spending. The Company remains focused on maintaining a solid balance sheet. As such, free cash flow would be expected to be used toward debt repayment

Over the next 12 months, DBRS expects the Company’s financial profile to reflect metrics that are more in line with the current rating, which is reasonable considering the rebound in industry demand and conservative financial policies.

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

The applicable methodology is Rating Companies in the Transportation Industry which can be found on our website under Methodologies.