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    Canadian Pacific Kansas City Ltd (CP)

    Q2 2024 Summary

    Published Feb 4, 2025, 6:40 PM UTC
    Initial Price$88.11April 1, 2024
    Final Price$77.50July 1, 2024
    Price Change$-10.61
    % Change-12.04%

    What went well

    • Strong revenue growth driven by both synergy realization and recovery in base business units, leading to significant operating leverage and setting the company apart from peers. RTMs are up almost 14% quarter-to-date, with expectations for a very strong Q3 and back half of the year. ,
    • The company is on track to exceed its synergy estimates, with revenue synergies expected to reach an exit run rate of approximately $800 million by the end of 2024, higher than initial projections. This outperformance is driven by strong growth in automotive, intermodal, and grain shipments into Mexico. ,
    • The significant capacity available across the network allows for growth without major capital expenditures, leading to higher margins as volumes increase. Management expects record operating ratio improvements in Q4 and is well-positioned for strong earnings growth in 2025 and beyond. , ,

    What went wrong

    • Near-term headwinds from higher casualty costs and increased stock-based compensation expenses are expected to impact the operating ratio in Q3, potentially preventing sequential improvement. Nadeem Velani stated, "In the near term, we're going to have a bit of a headwind. We had significant casualty costs that we faced in July that we're going to feel in the third quarter... perhaps not sequential improvement in the OR in Q3 because of some of those headwinds."
    • Strong volume growth is partly due to easy year-over-year comparisons from last year's strike, which may lead to a slowdown in growth rates as these effects normalize. Nadeem mentioned, "I think across the board, I think we're up almost 14% RTMs quarter-to-date. Now that's going to slow a little bit as we lap this strike benefit year-over-year or strike comp."
    • Reliance on revenue synergies may pose risks if they do not fully materialize, especially in areas like grain shipments to Mexico. While management is optimistic, uncertainties remain. John Brooks noted, "Being a grain guy, it's never made until it's in the bin, but we are pretty optimistic in Canada." Potential underperformance could impact expected synergy targets. , ,

    Q&A Summary

    1. Revenue Synergies Progress
      Q: How are revenue synergies progressing, and what's the expected exit rate for 2024?
      A: Revenue synergies are progressing strongly, with an exit run rate expected to reach close to $800 million by the end of 2024. This is ahead of the initial expectation to double from the $350 million exit rate at the end of 2023. The growth is spread evenly across the book, with about half in intermodal (international, domestic, automotive) and the other half split between bulk and merchandise businesses.

    2. Labor Disruption Impact
      Q: Can you provide an update on the labor situation and potential impact on operations?
      A: A likely work stoppage due to labor negotiations with the TCRC is anticipated, potentially occurring at the end of August. While the parties remain at the table, they are far apart. The expected work stoppage has been factored into current guidance and may have some operational impact, but the company believes it's prepared and has accounted for it in its outlook.

    3. Operating Ratio and Cost Headwinds
      Q: What is the outlook for the operating ratio and margin expansion, considering cost headwinds?
      A: The company expects a strong back half of the year, with an anticipated record operating ratio in Q4. Some near-term cost headwinds include higher casualty costs of about $45–50 million in July and increased stock-based compensation. Sequential improvement in the OR may not occur in Q3 due to these factors, but significant improvement is expected in Q4.

    4. Capacity for Future Growth
      Q: How does the company view its capacity constraints and ability to handle future growth?
      A: The company is not capacity constrained in any way and is well-positioned for growth. Investments in infrastructure, including capacity expansion projects and the upcoming completion of the Laredo bridge, will improve train speed and velocity. The focus is on disciplined execution to match capacity with growth opportunities without oversubscribing the network.

    5. Pricing Trends and Inflation
      Q: How are pricing trends developing, and how is inflation impacting costs?
      A: Inflation is moderating, currently in the mid 3–3.5% range, while pricing remains strong at over 5%. The spread between pricing and inflation is widening, which is expected to accelerate margin expansion. The company has been accruing for anticipated labor cost increases and sees overall cost inflation slowing despite higher labor costs.

    6. Grain Season Outlook
      Q: What is the outlook for the upcoming grain season?
      A: The company is optimistic about a strong grain fall. The projected grain crop is around 73 million metric tons, with customers talking about possibly 75–78 million metric tons. The company is well-positioned with capacity and expects grain shipments to accelerate in the second half of the year.

    7. Strong RTM Performance
      Q: What is driving the strong RTM performance in early Q3?
      A: Revenue ton-miles (RTMs) are up almost 14% quarter-to-date, benefiting partly from lapping the prior year's port strike. Strength is seen across the board, with improvements in domestic intermodal and confidence in the new grain crop. This sets up for a strong Q3 and back half of the year.

    8. Potential Opportunities from Port Strikes
      Q: Are there opportunities arising from potential East Coast port strikes and trade shifts?
      A: Yes, potential East Coast port strikes could present opportunities. The company is engaging in dialogues with customers seeking alternatives and is testing flows through Lazaro Cardenas and the Port of Saint John. This could benefit cross-border and international intermodal business in 2025.

    9. Dallas Auto Compound Growth
      Q: What is the upside potential of the Dallas auto compound?
      A: The Dallas auto compound is expected to handle 160,000–180,000 vehicles annually on 35 acres. With 3 OEMs already signed on, reaching about 75% capacity, and additional OEMs in discussion, the facility has strong growth potential. The location is expandable, offering a unique solution that complements the network.

    10. Laredo Bridge Expansion
      Q: How will the Laredo bridge expansion impact capacity and service?
      A: The Laredo bridge expansion will improve train speed and velocity by eliminating current capacity constraints. It will allow for continuous train flows without four-hour windows, reducing queues and improving asset utilization. This enhancement supports future growth and differentiates the company in the marketplace.

    11. International Intermodal Strategy
      Q: What changes are occurring in the international intermodal business?
      A: The company is strategically rethinking its international intermodal partnerships, shifting some business with Costco and bringing on a corresponding piece of Ocean Network Express (ONE) business. The focus is on high-grading the overall franchise value and leveraging the entire network, including Saint John and Lazaro Cardenas. This may present opportunities in 2025, especially with new services announced at Lazaro Cardenas.

    12. Mexico Import Growth and Service
      Q: How is the Mexico import business performing, and what's the service quality?
      A: Service levels in Mexico have never been better, with recent tests showing imports through Lazaro Cardenas reaching Houston in 3.5 days on the rails. Building confidence in these service levels is leading to new service calls at Lazaro Cardenas, and customers are excited about cross-border opportunities.

    13. Higher Revenue Synergies than Expected
      Q: Where is the outperformance in revenue synergies coming from?
      A: Revenue synergies are outperforming initial expectations, with about half coming from intermodal and automotive sectors, and the other half split between bulk and merchandise businesses. Grain shipments into Mexico are stronger than anticipated, with an increasing number of trains running from Canada and the U.S. into Mexico.

    14. Cost Headwinds: Casualty and Compensation
      Q: What are the cost headwinds from casualty and compensation expenses?
      A: The company faced a significant casualty cost of about $45–50 million in July due to a derailment. Additionally, there will be a step-up in stock-based compensation costs in the third quarter. These factors contribute to near-term cost headwinds but are expected to be mitigated over time.

    15. Repricing of Legacy Contracts
      Q: Are there more legacy contracts to be repriced?
      A: The company is in the late innings of repricing its base book of legacy contracts inherited from the merger. Most contracts have been rolled over in the last 1.5 years, with only one significant contract remaining. This repricing has allowed for better alignment with current market conditions.

    16. Impact of Peso Volatility on Mexico Business
      Q: How is peso volatility affecting the Mexico business?
      A: The company has not felt a significant impact from peso volatility on its Mexico business. There has been no material effect on cross-border flows, and customers remain excited about intra-Mexico demand and cross-border opportunities.

    17. Capacity into Western Corridor
      Q: How is the company managing capacity into the Western corridor amid industry congestion?
      A: The company is not experiencing the congestion issues seen by others, as it avoids oversubscribing its network. By understanding its capacity limitations and maintaining disciplined execution, it ensures reliable service without deteriorating asset utilization.

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