CP: 3Q21 Revenues Rise, Outlook Revised (Update, Cowen)

Despite third-quarter 2021 supply chain challenges, Canadian Pacific’s (CP) “commitment to the foundations of precision scheduled railroading enabled us to respond quickly and effectively,” President and CEO Keith Creel said during the railroad’s earnings announcement on Oct. 20.

CP reported revenues of C$1.94 billion for the three months ending Sept. 30, 2021—a 4% growth over the same period last year (C$1.86 billion)—with revenue ton-miles (RTM) down 4%, FX (foreign exchange) down 3%, fuel costs up 5%, and price/mix up 6%.

CP also reported a “challenged Canadian grain outlook,” with a 40% decrease in crop size year-over-year. It noted that potash is “expected to perform well in Q4 as production comes back online” and the demand outlook “remains strong”; fertilizer and sulphur “performed well during the quarter as demand is high for nutrient replenishment.” Additionally, CP said it expects the automotive chip shortage to continue into 2022.

Other third-quarter 2021 highlights:
• Reported diluted earnings per share (EPS) of C$0.70, falling 20% from C$0.88 in third-quarter 2020; and adjusted diluted EPS of C$0.88, increasing 7% from C$0.82 last year.
• Reported operating ratio (OR) of 60.2%—including Kansas City Southern (KCS) acquisition-related costs—increased by 200 basis points from last year’s OR of 58.2%.
• Adjusted OR of 59.4%—excluding the KCS acquisition-related costs—rose by 120 basis points from third-quarter 2020’s OR of 58.2%.

Revised 2021 Outlook

CP said it “now expects low single-digit volume growth in 2021” (as measured in RTMs), compared with 2020, but “remains confident that it will deliver full-year double-digit adjusted diluted EPS growth in 2021.”

This revised guidance, CP noted, “continues to assume other components of net periodic benefit recovery to increase by approximately C$40 million versus 2020, an effective tax rate of approximately 24.6%, and capital expenditure of C$1.55 billion.”

“Despite global supply chain issues and a challenging Canadian grain crop, we remain confident in our ability to deliver full-year double-digit adjusted diluted EPS growth,” Creel said. “The underlying demand environment remains strong, and our commitment to generate sustainable, profitable growth will not be distracted by elements outside our control.”

Commenting on CP’s potential merger with KCS, Kreel said that the “transitory issues over the past year have only reinforced the need for enhanced competition and optionality for North American shippers. Our excitement about the opportunities ahead with the combined companies continues to grow.”

CP, like KCS during its third-quarter 2021 earnings report on Oct. 19, provided details on the merger’s next steps (see chart below). The railroad expects to obtain control approval from the Surface Transportation Board in second-half 2022.

The CP Investor Resources Page provides more details on its third-quarter 2021 financial results.

Cowen Insight: ‘An Anticipated Recalibration’

“CP came in slightly below our estimate and expectations on the bottom line, causing management to revise 2021 guidance downward on RTM growth, a change we believe to be well understood and seen in weekly carloading data,” reported Cowen and Company analysts Jason H. Seidl (Managing Director and Railway Age Wall Street Contributing Editor), Matt Elkott and Elliot Alper. “A strong pricing environment (seen in all the rails) should allow CP to benefit from revenue growth in the fourth quarter despite tough market conditions. Reiterate Outperform.”

Key Cowen Takeaways:

• “CP reported third-quarter adjusted EPS of CAD$0.88, modestly below our CAD$0.90 estimate and below the consensus forecast of CAD$0.94. Adjusted OR of 59.4% missed our 58.5% estimate, as higher than anticipated costs, particularly on the purchased services front (increased casualty costs, and the fires in British Columbia), led to the miss. Revenue grew 4% in the quarter despite a challenged volume environment.

• “Grain volumes were down 27% in the quarter, with crop size expected to be 40% below last year’s levels (this is similar to what we heard from CNI [Canadian National]), while the U.S. is expected to be far less challenged. Potash volumes were down 22% due to port maintenance and terminal upgrades; CP expects this segment to improve in the fourth quarter and into 2022. Quarter-to-date, our carload volumes suggest continued challenges, particularly in autos and grain.

• “Management revised 2021 RTM guidance downward and now expects low single-digit growth, in-line with what we believe to be expectations. However, it maintained the prior double-digit EPS growth for the year. Merger partner KSU [Kansas City Southern] ($301.14, Outperform) recently retracted its guidance given the uncertainties across the supply chain, and we would not be surprised to see other rails that have yet to report retract/revise guidance as well.

• “CP has approximately 25% of its book repricing in the fourth quarter, with pricing growth expected to be very similar to the growth we saw in 2021. While not going into great detail on pricing, we acknowledge that pricing in 2022 will have to be very cognizant of the inflationary environment given multiple companies so far through third-quarter earnings have highlighted the concerns around inflation.

• “Year-to-date, CP has generated CAD$1.2 billion in FCF and continues its guidance of CAD$1.55 billion in capex spend for the year. Due to the pending merger, CP has suspended its buyback program, and maintains 2.4x leverage, and following the KSU transaction, it will work to reduce leverage to its target range in approximately 24 months.

• “We adjust our 2021 and 2022 EPS estimates to USD$2.97 from USD$3.00, USD$3.45 from USD$3.40, respectively, while maintaining our 2023 EPS estimate of USD$3.80. Continuing to use our 21x multiple and our 2023 EPS estimate, our price target is maintained at $80. We await closing of the KSU deal to include the implications to our model.”