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Canadian Pacific Railway Limited (CP - Analyst Report), Canada’s second largest railway, reported adjusted earnings per share of C$1.28 (approximately $1.29) in the fourth quarter, in line with the Zacks Consensus Estimate. Adjusted earnings leaped 15% year over year. For fiscal 2012, adjusted earnings shot up 37.8% to C$4.34 per share (approximately $4.34).

Quarterly revenues climbed 6.7% year over year to C$1.5 billion (approximately $1.51 billion) due to volume expansion and strong pricing. The revenues were also in line with the Zacks Consensus Estimate. Revenues for full-year 2012 witnessed an increase of 10% to C$5.695 billion ($5.697 billion). The demand for rail service remained healthy across all business segments throughout the year.

In the fourth quarter, carloads (volume) and revenue ton-miles (RTMs), which measure the relative weight and distance of rail freight transported by Canadian Pacific, grew 1% and 4%, respectively. For the full year, carloads and RTMs increased 3% and 5%, respectively.

Operating income in the reported quarter witnessed a massive decline of 80% year over year to C$60.0 million (approximately $60.5 million). For 2012, operating income dropped 2% to C$949 million ($949.4 million).

Operating expenses increased 32% year over year to C$1.4 billion (approximately $1.5 billion) in the fourth quarter. Operating ratio (defined as operating expenses as a percentage of revenue) expanded 370 basis points year over year to 74.8% because of continued focus on maintaining asset efficiencies, safety measures and increased productivity.

Operating expenses in fiscal 2012 rose 12.0% year over year to C$4.7 billion ($4.75 billion), resulting in an operating ratio of 83.3%, down 200 basis points.

Liquidity

Canadian Pacific exited fiscal 2012 with cash and cash equivalents of C$333 million (approximately $333.1 million), up from C$47 million (approximately $47.6 million) a year ago. Long-term debt reduced to C$4.636 billion (approximately $4.638 billion) from C$4.695 billion (approximately $4.751 billion) last year.

Guidance

For 2013, the company estimated earnings of $4.34 and revenues in high single digits. Operating ratio is estimated in the low 70s. The company assumes average fuel cost per gallon of $3.45 per U.S. gallon. Tax rate is expected in the range of 25%-27% and exchange rates are expected to remain at par.

Other Stocks

Besides Canadian Pacific, other railroads that released their fourth quarter earnings include Canadian National Railway (CNI - Analyst Report), Norfolk Southern Corp. (NSC) and Kansas City Southern (KSU - Analyst Report).  While Canadian National’s earnings were in line with the Zacks Consensus Estimate, Norfolk and Kansas surpassed our expectations.  

Our Analysis

We believe high demand for each product group, long-term investments, and rising coal volumes resulting from an agreement with Teck Resources Limited (TCK - Snapshot Report) will lead to higher profitability in the future. Canadian Pacific remains on track to produce an operating ratio in the low 70s over the next three-to-five years.

This low operating ratio can be achieved through structural cost reductions, running longer and heavier trains equipped with distributed power, greater asset utilization as well as consolidating divisions, yards and shops. On the flip side, competitive threats, strong Canadian dollarand highly unionized workforce limit the upside to the stock.

Canadian Pacific has a Zacks Rank #3 (Hold) rating.

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