Canadian Pacific: “A chill from up North”

Canadian Pacific on June 21, 2016 provided an earnings outlook for the year’s second-quarter “due to lower-than-anticipated volumes in bulk commodities, such as grain and potash, the unexpected and devastating wildfires in northern Alberta and a strengthening Canadian dollar.”

CP said it now expects revenues to decline approximately 12% from the same quarter a year ago, adjusted diluted earnings per share of approximately $2.00 and an operating ratio of “about 62%.”

“Given the transitory nature of these impacts, CP remains confident in its business model and believes actions taken in the first half of the year, coupled with an anticipated improvement in commodity volumes, provide a path for the company toward meeting its full-year guidance,” CP said.

“CP will continue to focus on controlling costs in a difficult environment,” said CEO E. Hunter Harrison. “While we acknowledge the environment remains challenging, additional cost reduction opportunities and the potential for stronger volumes in the back half of the year still lead us to believe that achieving double-digit EPS growth in 2016 is a possibility.”

Cowen and Company Managing Director and Railway Age Wall Street Contributing Editor Jason Seidl described CP’s earnings outlook as “the chill from up North.”

“A weak freight market is driving carloads down, and ample truckload capacity and limited demand are keeping a tighter lid on pricing,” Seidl observed. “A stronger Canadian dollar and wildfires in Alberta negatively impacted results, too. CP’s operational and capital allocation proficiency keep us positive on the stock during a transitional period for volumes.

“CP announced that 2Q16 EPS will likely be 22% lower than consensus expected and 16% below our prior forecast,” Seidl noted. “The magnitude of the difference between guidance and consensus estimates is certainly significant and speaks to the challenging transport marketplace. If the company achieves double-digit EPS growth in 2016 as management thinks is still possible, and assuming the company puts up C$2.00 in 2Q16, then CP would need to achieve 28% year-over-year growth in 2H16 to meet its annual guidance.”

CP reduced headcount by 13% in 1Q16. Seidl believes the company “either maintained or accelerated that pace in 2Q16. A 62% OR implies a ~100 basis point year-over-year deterioration, and we think personnel reductions are a key component of that. As management alluded to last quarter, the company’s goal of doubling EPS from 2014 to 2018 is now more likely to occur in 2019, especially if 28% growth in 2H16 proves elusive. Broadly speaking though, the trends impacting CP are not unique to them. The Class I’s are all suffering from similar headwinds.”

Cowen lowered its estimates for all the Class I’s on June 17th and took down its forecast for CP’s 2Q16 revenue, EBIT and EPS forecasts (in C$ terms) by 3%, 5% and 7%, respectively. “However, as a result of the pre-announcement, we are taking our estimates lower,” Seidl said. “We are expecting the company to fall short of its double-digit 2016 EPS growth guidance as well. As such, we are revising our 2016 EPS estimate to C$10.35 (US$7.97) and 2017 EPS estimate to C$11.85 (US$9.24). That’s down from C$10.85 (US$8.35) and C$12.00 (US$9.36), prior. Our price target is also being reduced from US$168 to US$166. We think CP’s 2016 double-digit EPS growth guidance is aggressive because it would have to rely on improved volumes and further cost-cutting initiatives. While the company is in full control of the latter, the former may be difficult to attain.”

CP will release its second-quarter financial and operating results at 8:30 a.m. EDT on July 20, 2016. The company will discuss its results with the financial community in a conference call beginning at 11 a.m. EDT on July 20.