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Rating Action:

Moody's affirms Canadian Pacific's Baa2 rating

03 May 2007
Moody's affirms Canadian Pacific's Baa2 rating

Approximately $3.5 Billion Debt Securities Affected.

New York, May 03, 2007 -- Moody's Investors Service affirmed the debt ratings of Canadian Pacific Railway ("CP"), and assigned a (P)Baa2 rating to CP's $1.5 billion senior unsecured shelf registration. The rating outlook is stable. The affirmation considers CP's announcement that it has increased its normal course bid authorization to repurchase up to about 9.8% of its shares outstanding over the next year. If fully executed, this program could require approximately $1 billion in funding at CP's current share price.

While incremental borrowings that would be needed to fund a full execution of the program would weaken the company's financial metrics and could place pressure on the existing rating, the company will implement the program over the course of the year. In maintaining the current rating and outlook, Moody's anticipates a metered execution of the program and that CP would stop repurchasing shares if its business outlook weakens.

"The magnitude of the program is at the limit of the amount of share repurchase that would be consistent with the current rating" noted Bob Jankowitz of Moody's Investors Service. Consequently, any further increase in repurchase authorizations, or more rapid execution of the current program, particularly in the context of any shortfalls from the company's expected operating performance, could adversely affect the ratings or rating outlook.

In addition to CP's expected free cash flow of $300 million, funding the full program could require approximately $700 million more debt. Moody's expects that CP would constrain the amount of any debt increase and share purchases absent a continued positive outlook on its business in order to maintain financial and operating metrics consistent with its Baa2 debt rating.

Even so, the "the total amount of the debt increase would be one of the largest for shareholder enhancements among the major railroads, and comes at a time when softer economic conditions could begin to weaken overall demand for rail transport services", according to Bob Jankowitz of Moody's.

Affirmation of the Baa2 rating considers the higher debt level that would result from the repurchase activity and relys on CP's plan to achieve, and to then sustain, the higher profits and cash flow to preserve credit metrics consistent with CP's current rating level.

According to Moody's, the move to a higher level of debt comes very soon after CP achieved debt metrics consistent with other issuers also rated at the Baa2 level. CP made steady, and collectively meaningful, progress in financial performance particularly during the last 18 months. Over the last three years, a period of steadily increasing demand for railroad transportation, CP cut debt to EBITDA in half and more than doubled EBIT to interest expense.

The increased debt (about 16% greater than debt at fiscal year end December, 2006 if the program is fully funded and using Moody's standard adjustments) with stepped up shareholder enhancements via share repurchases and dividends would be a departure from the company's historically balanced financial practices. These included working towards achieving a more moderate level of financial leverage consistent with the high fixed costs and the especially high level capital investment characteristic of the railroad industry, and maintaining flexibility through liquidity and debt capacity to cushion the cash flow volatility of the industry over the cycle.

Moody's notes that execution of the program to increase financial leverage could occur after the transportation cycle has already peaked. While CP's near-term results are likely to be consistent with management's disclosed guidance, CP could be challenged over time to sustain the higher level of cash flow and profits particularly if it becomes more difficult to preserve the significant recent increases in yield at the same time that demand weakens. To maintain the Baa2 senior unsecured rating, Moody's expects that CP would need to sustain retained cash flow to debt at least in the low 20% level, EBIT to interest greater than 4x, capital investment to revenue consistent with the industry leaders, and service metrics over time consistent with the levels recorded during fiscal year 2006 including velocity at least 23 to 24 mph, and terminal dwell of less than 24 hours. Any incremental debt-funded share purchases without sustaining an operating ratio and free cash flow consistent with CP's current forecasts could pressure the outlook or the rating down.

Assignments:

..Issuer: Canadian Pacific Railway Company

....Senior Unsecured Shelf, Assigned (P)Baa2

Canadian Pacific Railway, based in Calgary Alberta, operates a transcontinental railroad.

New York
Michael J. Mulvaney
Managing Director
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

New York
Robert Jankowitz
Senior Vice President
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

No Related Data.
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