Don’t Be Tricked by Canadian Pacific Railway Limited’s Q3 Results

Canadian Pacific Railway Limited (TSX:CP)(NYSE:CP) had a good quarter, but foreign exchange gains played a big part.

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Canadian Pacific Railway Limited (TSX:CP)(NYSE:CP) released its third-quarter results on Tuesday. The company posted a modest 2% growth in its sales, but earnings per share of $3.50 were up 50%. Investors reacted positively to the release, as the stock reached a new 52-week high in trading on Wednesday. Canadian Pacific Railway also boosted its forecast for the full year with growth in earnings expected to be in the double digits.

Let’s have a deeper look into the railway operator’s results to see if the stock is still a good buy.

What drove the sales growth?

Canadian Pacific Railway tracks nine different freight revenues, and more than half were down this quarter. Grain revenue saw the largest decrease of $21 million as carloads were down 5%. Automotive-related freight also dropped $18 million in sales and saw the biggest drop in carloads, with a 13% decline this quarter. Fertilizer and sulphur also saw a double-digit drop in revenue with $12 million less this quarter coming as a result of a 3% drop in carloads. Intermodal and forest products were the other two segments that showed declines in revenue this quarter and combined for a decrease of $10 million in sales.

On the plus side, metals, minerals, and consumer products saw a $50 million rise in revenue as carloads were up 36% year over year. Potash had the second-largest growth with revenue rising $22 million, as it saw a near 20% increase in activity. Energy, chemical, and plastics were not far behind, as the segment contributed an additional $21 million in revenue for the quarter on a 13% increase in carloads. Coal-related revenue saw the smallest increase with $5 million in additional sales this year.

Increased revenue was the primary reason for the operating income

The improvement in the company’s foreign-exchange adjusted operating income was 7%, but with expenses up 3%, it was sales growth that fueled the company’s improved bottom line.

Foreign exchange played a big role in producing a strong quarter

Operating income was up 5% for the quarter, and it was the company’s foreign-exchange gains that led to the strong growth in net income. Last year, the company’s other income and expense line added $71 million to its costs, while this year that line item added $105 million to income for a total improvement this quarter of $176 million.

A breakdown of this line item shows that the entire benefit this quarter came from foreign exchange gains (mainly from changes in the company’s long-term debt), whereas last year the company incurred a $46 million expense. As a result of this large swing in foreign exchange, the company saw a 45% increase in its income before taxes. Without the gain from foreign exchange, the company’s net income before tax would have been just 22%, as it still would have benefited from the currency impact in last year’s totals.

What this means for investors

Canadian Pacific Railway had a good quarter, but its profits don’t tell the whole story. A headline of the railway operator posting a 47% improvement in its profit sounds great, but it can be misleading since much of that improvement isn’t directly related to the company’s operations. Foreign exchange can create a lot of uncertainty, and a gain this year could be a loss in the next.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor David Jagielski has no position in any stocks mentioned. 

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