DBRS Confirms Canadian Pacific Railway at BBB, Changes Trends to Positive

DBRS Limited (DBRS) confirmed all ratings of Canadian Pacific Railway Company (CP or the Company) and changed all trends to Positive from Stable. The confirmation action and change in the trends reflect the Company’s moderately improving credit metrics as the North American economic recovery progresses, a more conservative financial policy as demonstrated by the renewed commitment to fund share repurchases with net free cash flow, a business risk profile that exceeds levels commensurate with the current ratings and a continuing focus on cost efficiency improvements. However, DBRS notes that while a strengthening Canadian dollar has a positive impact on CP’s USD-denominated debt, it could also create headwinds for further revenue growth and cost efficiency improvements.

DBRS believes that the early stages of a recovery of the North American freight railway industry has begun, based on the rebound in the U.S. and Canadian economies. This, in part, has resulted in CP’s revenue-tonne-mile (RTM) metric increasing by 3.7% in the last twelve months ending September 30, 2017 (LTM September 2017), compared to 2016. Overall, volumes improved in LTM September 2017 compared to 2016, with Bulk, Merchandise and Intermodal improving by 4.4%, 3.0% and 1.9%, respectively. During the same period, Canadian grain exports volumes improved by 3.0% compared to 2016. The relatively dry growing season in the Prairies has resulted in Statistics Canada recently providing an updated 2017 grain crop estimate of 66 million tonnes, compared to 71 million tonnes in 2016, which should result in moderately lower grain shipments this season. That said, CP has continued to focus on capacity management and efficiency, reducing average total employee count by 17% since the end of 2014 while maintaining the improving trends in all operating measures except fuel consumption and average train weight. As a result, CP’s operating ratio continues to improve, declining to 57.4% in LTM September 2017 compared to 58.6% in 2016. Consequently, improving credit metrics are evidenced by operating cash flow and earnings improving, with adjusted debt-to-EBITDA decreasing to 2.5 times (x) for LTM September 2017 from 2.8x in 2016 and adjusted cash flow-to-debt improved to 28% from 25% during the same period.

Assuming that CP maintains its efficiency focus, its strong operating ratio, its commitment to fund share re-purchases from free cash flow and further improvement in its credit metrics in the near term, then a positive rating action could result. Alternatively, a return to debt issuances as a means of replacing free cash flow to fund share repurchases that weakens the recovery of CP’s credit metrics could result in a negative rating action.

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

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 to the right under Related Research or by contacting us at info@dbrs.com.

The principal methodologies are Rating Companies in the Railway Industry (February 2017) and DBRS Criteria: Commercial Paper Liquidity Support for Non-Bank Issuers (March 2017), which can be found on our website under Methodologies.

The rated entity or its related entities did participate in the rating process. DBRS had access to the accounts and other relevant internal documents of the rated entity or its related entities.

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