For CP, a tough second quarter

The second quarter of 2016 was not kind to Canadian Pacific, though in line with CP’s quarterly outlook, released in June.

Based on declines in revenues, operating income and net income, CP’s second-quarter diluted earnings per share (EPS) were $2.15, or $2.05 on an adjusted diluted EPS basis, 9% lower than the prior-year quarter’s $2.36 diluted EPS and 16% lower than last year’s $2.45 adjusted diluted EPS. CP cited a 12% drop in revenues as the primary factor.

Compared to second-quarter 2015, CP’s revenues fell to $1.45 billion from $1.65 billion. Operating income decreased 15% to $551 million from $646 million. Net income declined 16% to $328 million. Adjusted income fell 23% to $312 million.

CP’s operating ratio increased 110 basis points to 62% from 60.9%

“Revenue challenges in the second quarter, as noted in our quarterly outlook release last month, included lower-than-anticipated bulk volumes, devastating wildfires in northern Alberta and a strengthening Canadian dollar,” said CP Chief Executive Officer E. Hunter Harrison. “Despite these challenges, our team of dedicated railroaders continues to perform, and their hard work and focus on service, safety and controlling costs positions CP well for the rest of the year. Our business model provides the flexibility and capacity to take advantage of changing market conditions. As volumes increase, we are well-equipped and ready to respond accordingly.”

“CP is forecasting a strong Canadian grain crop in 2H16,” said Cowen and Company Managing Director and Railway Age Wall Street Contributing Editor Jason Seidl. “Management thinks it could be a record year on the back of a 4.6% grain cap. Additionally, the company is focusing on improving its productivity in the grain franchise by 20%, which will play out in the coming quarters. The company will also be rolling out trip plans for every single non-bulk car on its network in 3Q16. Those are key drivers of management’s hopefulness for a better than expected second half of the year. Over time, we think there are several reasons to be excited about the potential operational improvements this company is making. Trip plans will likely be the last major project that Hunter Harrison focuses on before his retirement next year.

“CP’s pre-announcement lowered the EPS bar by about 20% on June 21 and today exceeded those revised expectations. Adjusted EPS of C$2.05 fell 17% y/y, but was ahead of our C$2.01 estimate and consensus’ C$2.04. CP’s operating ratio was in line with our 62% forecast, but 50bps worse than what consensus was looking for. The company was unable to achieve any operating leverage in the quarter as revenue fell 12%, adjusted EBIT fell 15% and adjusted EPS fell 16% amidst soft freight demand and wildfires in Alberta.

“The U.S. dollar was nearly 5% stronger y/y but depreciated 6% from 1Q16’s average. Outside of the U.S. denominated debt translation, we estimate that the stronger USD had a 3% y/y benefit to pre-tax earnings. On a sequential basis, the Canadian dollar, which was 6% stronger in 2Q16 vs. 1Q16, had a 4% negative impact on pre-tax earnings, in our estimation. In order to achieve double-digit earnings growth in 2016, which management still believes is possible, CP would have to grow EPS by 27% in 2H16. We have chosen to remain more conservative.

“We are raising our C$ EPS estimate from C$10.35 to C$10.40 and our 2017 estimate from C$11.85 to C$11.95. Our USD equivalent estimates are now higher as well. As a result, our share price target is $168 (up from $166) as we maintain the 18x multiple on our new US$9.32 2017 EPS estimate. Our 18x multiple falls slightly below the average of the stock’s three-year historical range of 12-28x.”

CP’s earnings report came with the announcement that Hunter Harrison will hand the throttle over to President and Chief Operating Officer Keith Creel in mid-2017.