CP’s operating margin
In the transportation sector, operating margins matter a lot and are represented by the operating ratio metric. The higher the operating ratio, the lower the operating margin will be, and vice versa. In 4Q17, Canadian Pacific Railway’s (CP) operating margin expanded slightly by 10 basis points to 43.9% compared to 43.8% in the corresponding quarter of 2016.
Note that CP’s total operating expenses jumped 4% to 960.0 million Canadian dollars in 4Q17, whereas its revenue rose 5% in the same quarter. Adjusting for foreign exchange fluctuations, the company’s revenue and operating expenses rose 7% each.
Operating expense breakup for 4Q17
In 4Q17, Canadian Pacific Railway’s compensation and benefits expenses fell 5% to $269.0 million from $282.0 million a year ago. Higher stock-based compensation expenses, labor inflation, and improved volumes slightly offset increased pension income and operating efficiency. At the end of 2017, CP’s employee base was 5% higher at 12,000, though it was flat compared to 2Q17.
The company’s fuel expense was $197.0 million in 4Q17, a rise of 19% compared to $173.0 million in 4Q16. This rise was the result of higher fuel prices in 4Q17, which pushed up the operating ratio by 1%. CP’s purchase services expenses stood at $244.0 million, representing a rise of 13%. Its 4Q17 operating expense rise was offset by a $37.0 million gain on the sale of its Obico rail yard.
Management insights for 2018
For 2018, Canadian Pacific Railway expects to expand its core operating margins by 1%–2%. The company anticipates net tailwinds of $94.0 million for pensions in 2018. The implementation of new GAAP (generally accepted accounting principles) should add $112.0 million to CP’s other income in 2018 compared to the levels it attained last year. The change in pension accounting is expected to inflate the company’s operating ratio from the mid-50s to the high-50s in 2018.
Among CP’s Class I railroad (UNP) peers who have reported their results so far, CSX (CSX) reported a 2.2% expansion in its 4Q17 operating margin due to its former CEO, Hunter Harrison, shifting toward a precision scheduled railroading model. Kansas City Southern’s (KSU) operating margin was 36% in the quarter, an expansion of 0.8% year-over-year. Major US railroad companies (XTN) (NSC) will have a tough challenge ahead of them in maintaining their operating margins amid freight volume growth in 2018.
In the next article, we’ll consider analysts’ views on Canadian Pacific Railway after its 4Q17 results.