5 Things Canadian Pacific's Management Thinks You Should Know

The change in the U.S. tax code is so significant that even Canadian companies such as Canadian Pacific Railway (NYSE: CP) are feeling the effects on their bottom line. This past quarter, the company logged a significant one-time gain thanks to those changes , but the more important story was that it was able to deliver exceptional operating results while overall rail traffic ticked up.

Numbers this good might make you think that there isn't a whole lot of room left to run, but Canadian Pacific's management seems to think otherwise. Here are quotes from the most recent quarterly conference call that highlight why the company thinks things will get better from here.

A red CP locomotive with the Canadian and U.S. flags on either side riding on a track with snow on the ground

Image source: Canadian Pacific Railways.

Things looking up across almost all sectors

I can't think of a better economic bellwether than railroad companies. As the go-to shipping method for agricultural products, commodities, energy, autos, and, and intermodal transport, you can learn a lot about the health of various sectors based on shipping volumes. With that in mind, investors have to be feeling good about Canadian Pacific and the economy in general when CEO Keith Creel dropped this line during the conference call.

[W]e battled severe winter weather across our network as we closed out the quarter as well. But in spite of these challenges, the operating results were solid. They enabled us to produce record revenues and Canadian grain and domestic intermodal. In fact in '17, we achieved record or new record levels for a number of our key commodities. Potash at new record levels, record levels for Canadian coal domestic intermodal, metals and minerals.

What is even more encouraging is that these results span a wide variety of products. This should give investors reasonable confidence that this economic growth phase will continue for some time.

Smashing operating records

Whenever a transportation and logistics company runs at record levels, it typically means that capacity is strained and can lead to higher incident rates or higher costs. Surprisingly, that wasn't the case this past year. According to Creel, Canadian Pacific's safety record was incredibly strong.

And an equally encouraging strong performance on the safety front as well with personal injuries down 16%, train accidents down 21% for the quarter. On a full year basis, our train accidents frequency finished in all time low, marking the 12th consecutive year CP has lead the industry in this key safety metric.

CFO Nadeem Velani also noted that the company's operating statistics were equally robust.

For the year, revenues grew 5% and adjusted operating income grew 6%. Our full year adjusted operating ratio was 58.2%, which is 40 basis points better than the record set in 2016. Similar to the quarter, the OR improvement is even more impressive, considering headwinds from fuel price, incentive comp and a few favorable one-time items in 2016.

According to Velani, fuel costs for the fourth quarter were up 19% compared to this time last year. So, to post a lower operating ratio -- the railroad industry's lingo for operating income margin, which is operating expenses divided by revenue -- while shelling out that much more for fuel is quite a feat.

Don't fret fewer share repurchases

Railroads aren't what you would call a high growth industry. Delivering mid- to high-single digit earnings growth is considered a great year. What makes these companies great investments is their ability to deploy free cash flow for dividends and share repurchases. That earnings growth rate, coupled with a share repurchase program, can quickly translate into double-digit earnings-per-share growth.

During the conference call, Velani mentioned that Canadian Pacific's share repurchases for the upcoming year may be a little lighter than normal. That sounds a bit strange after announcing good results and an improving outlook for 2018. He explained, though, that investors shouldn't be overly concerned because this is a short-term matter.

One thing to keep in mind as far as future program, in the first half of 2018, we have a total of about $575 million high coupon debt maturing, which we've refinanced at lower rate. We may also take advantage of the opportunities to actively de-lever and retire some of this debt, so you should expect lower interest expense in 2018. But at the same time, this would likely push decisions on future share repurchases beyond our current program to Q4. This would allow us to align free cash generation with our shareholder cash return.

One of management's other stated goals is to reduce Canadian Pacific's debt leverage -- measured by adjusted net debt to adjusted EBITDA -- into the 2.0 to 2.5 times range. At the end of the quarter, the company's leverage was 2.6 times. The retirement of some debt now should therefore put it in the desired range and reduce interest expenses, which should translate to more free cash flow in the future.

CP data by YCharts .

Capitalizing on a competitor's weakness

A rival's crisis is a terrible thing to waste. This past quarter, Canadian Pacific's largest competitor, Canadian National Railway (NYSE: CNI) , had some capacity issues for its Canadian grain shipments and its CEO stepped dow n. Needless to say, Wall Street hasn't been entirely happy with the situation. So, of course, Canadian Pacific is using this as an opportune time to invest in its grain capacity. Here's Velani with the capital spending outlook for 2018.

[A]s noted in our guidance, we plan to spend between $1.35 billion and $1.5 billion in capital. The primary reason for the wide range on CapEx is due to this possibility of investing in upgrading our grain hopper fleet, which we've mentioned in the past.We're awaiting the final outcome of bill C49 for making a decision. That being said, the supported changes are positive and investing in a modernized grain hopper fleet would have substantial benefits to both CP and our customers. If all goes as planned, we might be investing in hoppers later this year but the timing and full amount is yet to be determined. In terms of share repurchase, we should expect us to complete our NCIB, which we announced last May. So far, we've repurchased about half the program at an average cost of $202 per share.

What a Fool believes

Canadian Pacific put together another good quarterly performance where it was able to deliver better operational performance without sacrificing too much for capacity and safety. That is critical because cutting costs to the bone can expose a railroad company to significant disruptions if there isn't sufficient spare capacity to cover for a minor incident -- see Canadian National. Investors should also be excited to see management take advantage of a competitor's weaknesses to potentially grow its agriculture segment, even if it means that it will back down from its share repurchase program for a while.

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Tyler Crowe owns shares of Canadian National Railway. The Motley Fool owns shares of and recommends Canadian National Railway. The Motley Fool has a disclosure policy .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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