Canadian Pacific Earnings: Intermodal Container Activity Challenged, but No Major Surprises

Wide-moat Canadian Pacific Kansas City’s CP second-quarter pro forma revenue (combining CP and Kansas City Southern results; merger finalized in April) fell 3% year over year, excluding foreign exchange. The decline was driven by lower overall volumes and now-falling fuel surcharges. Revenue came in shy of our forecast due to greater-than-expected intermodal deterioration.

Total pro forma volume fell 2% due to sluggish industrial end markets, lower potash (customer facility issue), and significant intermodal weakness from retail-sector inventory destocking and sluggish imports. These factors were only partly offset by solid new business wins over the past year, as well as higher grain (lingering Canadian harvest benefits) and automotive carloads (higher vehicle production). Pro forma yield fell 1% (excluding foreign exchange) on lower fuel surcharges and easing accessorial income, though core pricing remains positive and CP is committed to inflation-plus rate hikes.

CP’s pro forma adjusted operating ratio (expenses/revenue) deteriorated 430 basis points to 64.6% on lost leverage from lower volumes, material wage inflation, and a nonrecurring spike in casualty costs related in part to a derailment. Management did not provide specific OR guidance, but—as we heard it on the call—the firm thinks the OR can improve sequentially in the third quarter, assuming it claws back volume lost during the early July Canadian west coast ports strike.

We will likely temper our 2023 model assumptions, but we don’t expect to drastically alter our $71 USD-denominated fair value estimate. In our view, CP has the strongest management team among Class-I rails, with significant growth opportunities, but the shares look slightly rich relative to our longer-term free cash flow growth forecasts.