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Canadian Pacific Railway's Earnings Get Hit With Bad Weather & High Costs in Q1

By Tyler Crowe – Apr 19, 2018 at 9:54AM

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It can be expensive to move record volumes of freight when your rail network gets disrupted by winter weather.

After an incredible fourth quarter, the first quarter of 2018 wasn't Canadian Pacific's (CP -1.76%) finest showing. While carloads and revenue continue to increase, operating costs are growing faster. If that weren't enough of a concern, management has been notified that its union workers intend to strike in the coming days. 

Let's take a look at Canadian Pacific's most recent results, what its employees are demanding in this strike, and what it could all mean for the company and its shareholders.

A red Canadian Pacific locomotive running on a track under white clouds.

Image source: Canadian Pacific Railway.

By the numbers

Metric Q1 2018 Q4 2017 Q1 2017
Revenue $1.62 billion $1.71 billion $1.60 billion
Operating income $540 million $753 million $604 million
Net income $348 million $984 million $431 million
EPS (diluted) $2.41  $6.77 $2.94 

In Canadian dollars. Data source: Canadian Pacific earnings release. EPS = earnings per share. 

Because of some recent changes to the way Canadian Pacific has to report its earnings, it's incredibly hard to make an apples-to-apples comparison of its results. The two most significant changes are the manner in which it's required to report its pension costs and the one-time gain of 527 million Canadian dollars in the prior quarter related to changes in U.S. taxes.

In the quarter, Canadian Pacific's compensation and benefits costs went up by 27% compared to the prior year. Fuel costs were also up 31% compared to this time last year. These two items represent two of Canadian Pacific's largest expenses and, as a result, its operating ratio spiked from 56.1% in the prior quarter to 67.5%. According to the press release, the company faced several weather-related issues, as well as higher-than-usual demand on its network, which strained capacity and elevated costs. Adjusting for the changes in pension reporting, the prior quarter's operating ratio would have been 60.2%. So it's not as bad as the headline numbers say, but it still isn't great.

The one positive to take away from this quarter is that revenue and total carloads keep rising thanks to great demand for shipments in its energy and intermodal sections.

CP revenue by business segment for Q1 2017, Q4 2017, and Q1 2018. Shows losses in grain offset by energg & chemicals and Intermodal.

Data source: Canadian Pacific Railway earnings release. Chart by author.

Perhaps more concerning than these numbers was the announcement that the unions representing Canadian Pacific's employees have issued a 72-hour notice for their intent to strike. One of the most pressing issues from the union is to get more predictable schedules for its workers to combat fatigue. It's pretty easy to draw a conclusion from this issue, along with fast-growing volumes and rapidly increasing operating costs, that Canadian Pacific may be constrained by capacity. 

What management had to say

This was an unusual quarter for Canadian Pacific, which CEO Keith Creel tried to emphasize in the press release. He also hinted that we could see a much better outcome next quarter.

This was a challenging quarter, as we battled extreme weather and unprecedented demand, specifically in the northern reaches of our network. Despite these challenges, we delivered 6 percent more freight than last year, demonstrating once again the resiliency of our operating model and the commitment from our family of professional railroaders. With the extraordinary winter weather behind us, we built a tremendous amount of momentum through March-one of our best months in recent history-positioning us well for the rest of the year.

What a Fool believes

From an investor's standpoint, there is a critical question worth following up on in the coming quarters: Was this quarter an anomaly because of weather, or is Canadian Pacific's network becoming overworked to the point where operating costs are going to run higher for the foreseeable future? This is a question that can't be answered with one quarter of results, but it will likely be the defining theme for Canadian Pacific's stock for the rest of 2018. It's clear that capacity expansion is a priority for the company because its 2018 capital spending is up significantly in 2018. 

Canadian Pacific is one of the best-run railroad companies in North America, so management should be given the benefit of the doubt when it comes to a bad quarter. Also, this strike could lead to another quarter of lower earnings if not resolved quickly. All in all, though, there isn't anything in this report that should be overly concerning for investors. 

Tyler Crowe has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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