Tuesday, December 04, 2012

CP’s Harrison: A “mid-60s” operating ratio by 2016

Written by  William C. Vantuono, Editor-in-Chief
At an investor conference in New York on Tuesday, Dec. 4, Canadian Pacific’s recently installed President and CEO E. Hunter Harrison outlined his plan for taking the railroad out of last place among North American Class I’s in terms of operating ratio, productivity, cost structure, business growth, and other performance measurements.

“Momentum is building at Canadian Pacific, and the organization is driving to a culture of intense focus on operations,” said Harrison. “Service will be what drives this organization, by providing a premium, reliable product offering through a lower cost operation. We have initiated a rapid change agenda and have made tremendous progress in my first 160 days, and we are only getting started.”

Harrison provided various examples of steps taken over the past five months highlighting CP’s “evolution to a more competitive railway”:

• A new executive leadership team in place including a new Senior Operations lead team with a mandate for “centralized planning and decentralized execution, to eliminate bureaucracy and have service decisions made faster and closer to the customer.”

• Revamped intermodal and merchandise train service resulting in faster transit times for customers, for example, new intermodal services connecting Vancouver to Chicago or Toronto.

• Closure of hump-switching yards in Toronto, Winnipeg, Calgary, and Chicago, “producing significant cost savings and more efficient operating practices.”

• Closure of intermodal terminals in Milwaukee, Obico (Toronto), and Schiller Park (Chicago), “reducing footprint and operating expenses while also facilitating efficient operating practices and reduced end-to-end transit times.” <>• Improved train service and network velocity resulting in the need for 195 fewer locomotives and 3,200 fewer leased railcars. Current stored, year-to-date lease returned and declared surplus locomotive units total 460.

Harrison outlined the next steps CP will take through 2016 to continue “to improve service reliability, increase the railway’s efficiency, and grow the business.” He is targeting a full-year operating ratio in the mid-60s by that year. Among the key initiatives:

• Annual capital spending in the range of $1.0-$1.1 billion.

• Reduce roughly 4,500 employee and/or contractor positions by 2016 “through job reductions, natural attrition, and fewer contractors. We have already made progress on this front and expect 1,700 positions to be eliminated by year’s end.”

• Construction of new, longer sidings program to improve asset utilization and increase train length and velocity, allowing CP to move the same or increased volumes with fewer trains, and potentially reduce crew starts by 14,500, or 4%.

• Explore options to “maximize full value of existing and anticipated surplus real estate holdings.”

• Relocate CP’s current corporate headquarters in downtown Calgary to new office space at CP-owned Ogden Yard by 2014.

• Review options for the Delaware & Hudson (D&H) in the U.S. Northeast, while maintaining options for continued growth in the energy business.

Turn over operations of the 660-mile portion of the former Dakota, Minnesota & Eastern (DM&E) west of Tracy, Minn., to a short line. CP is currently seeking expressions of interest.

With these programs in place, CP, Harrison said, expects in 2016 to see compound annual revenue growth of 4% to 7% off the 2012 base, cash flow before dividends of $900 million to $1.4 billion in 2016, and a full-year operating ratio in the mid-60s. All of this is dependent upon certain “key assumptions.”:

• Average fuel cost per gallon of $3.45 U.S. per U.S. gallon.

• Defined benefit pension expense of $140-$150 million through 2016.

• Defined benefit pension contributions between $100 and $125 million through 2015, increasing to $200-$300 million in 2016.

• A tax rate of 25-27%.

• CP becoming fully cash taxable during the four-year period.

• Canadian to U.S. exchange rate at par.

As previously announced, CP is scrapping plans to build a new line into the Powder River Basin coal fields and anticipates taking a fourth-quarter 2012 estimated pre-tax non-cash charge of approximately $180 million ($107 million after tax) on its option, inherited from the DM&E acquisition, to build into the PRB. CP also anticipates taking a charge related to labor and other restructuring activities, the amount of which is under review.

“We now have a leadership team that understands the urgency of making change and improving the culture of this organization,” Harrison said. “CP has many talented railroaders who want to win. Together we are squarely focused on improved service and becoming the low cost carrier. This will allow us to continue to grow with our customers. We are hearing feedback from customers that they are seeing and liking the results. The reduced number of assets and the decentralized decision-making within the organization will allow us to appropriately size to any changes in market conditions. I have always maintained that by focusing on the best possible service, along with appropriate cost containment, the operating ratio will take care of itself. CP is no different; we already see the service and related bottom line benefits of our early actions. It's an exciting time to be a part of this great franchise.”

“I am excited about what we’ve achieved to date, but we have only just started this journey to being a more competitive railway,” Harrison said. “We will continue to drive our service offering while focusing on taking unproductive costs out of the business. We see a strong earnings profile and solid free cash flow picture emerging. Canadian Pacific is a great franchise with strong growth upside and we are more confident than ever that we will drive shareholder value long into the future.”