Canadian Pacific - RBC

PRICE TARGET REVISION | COMMENTFEBRUARY 11, 2009

Canadian Pacific Railway (TSX: CP; NYSE: CP)

Resuming Coverage Following Secondary Offering

Sector PerformAverage Risk

Price: 38.20

Shares O/S (MM): 155.0Dividend: 0.99Float (MM): 155.0Debt to Cap: 44%

Price Target: 51.00 ↓ 54.00Implied All-In Return: 36%Market Cap (MM): 5,921Yield: 2.6%Tr. 12 ROE: 11.00%Avg. Daily Volume (MM): 1.10

Event

Resuming coverage following secondary offering. Q4/08 results.

Investment Opinion

• $510MM secondary offering strengthens balance sheet. Following therelease of the company's Q4 results, CP announced a 13.9MM share offering(inc. greenshoe) for proceeds of $510MM. While the offering was a surprise tous, we believe the underlying motivation was to firm up the balance sheet andprotect the investment grade rating of the company's debt. We estimate theoffering to be dilutive by 5% in 2009 and 7% in 2010.

• Q4/08 above expectations. Q4/08 EPS came in at $1.15 vs. our estimate of$1.02 and down from last year's $1.20. The main variance to our estimate wasthe fuel surcharge lag ($0.10 impact) and a lower tax rate ($0.04 impact).

• Pricing remains solid. The key takeaway in the quarter was on pricing. Pricerenewals were a robust 6% (exc. fuel s/c), a strong showing given that thesenegotiations were achieved during a period of considerable weakness in Q4.Management maintained that they will continue to seek contract renewals in2009 of 4%-5%, and based on our discussions with CP's customers, these priceexpectations are echoed by the shippers. The one exception is Teck Coal, wherenegotiations may prove difficult given the current outlook for metallurgicalcoal. We are assuming flat pricing vs. 2008 on the company's met coalbusiness.

• Reducing estimates. As we have done for the other railroads reported, we areadjusting further downward our volume assumptions for 2009, and we are alsoincluding the dilutive impact of the share offering. The net impact is areduction to our EPS estimate to $3.95 (from $4.18) in 2009E and $4.52 (from$4.79) in 2010E.

• Maintaining Sector Perform. With Q4's variance to our estimate being largelyattributable to tax and fuel surcharge lags, the Q4 results did not lead us toanticipate significant outperformance by CP in terms of operating results whencompared to the group going into 2009. Likewise from a valuation standpoint,the shares are trading at 9.7x, which is only slightly below the group average of10.1x. Accordingly, we are maintaining our Sector Perform, Average Riskrating. Our price target goes to $51 (from $54) on the back of our loweredestimates.

Priced as of prior trading day's market close, EST (unless otherwise noted).

125 WEEKS 29SEP06 - 10FEB09

40.00

48.00

56.00

64.00

72.00

80.00

88.00

SO N2006

D J F M A M J J A S O N2007

D J F M A M J J A S O N2008

D J FHI-20JUL07 91.00HI/LO DIFF -62.37%

CLOSE 38.20

LO-21NOV08 34.24

2000400060008000

10000

PEAK VOL. 12996.7VOLUME 1904.0

100.00

110.00

120.00

Rel. S&P/TSX COMPOSITE INDEX HI-20JUL07 126.28HI/LO DIFF -28.24%

CLOSE 91.70

LO-30JAN09 90.62

RBC Dominion Securities Inc.

Walter Spracklin, CFA (Analyst)(416) 842-7877; [email protected]

Jennifer Maeba, CFA (Associate)(416) 842-7862; [email protected]

Hiyam Jibry (Associate)(416) 842-7862; [email protected]

FY Dec 2007A 2008A 2009E 2010E

EPS (Op) - FD 4.32 4.06 3.95 4.52

Prev. 3.95 4.18 4.79

P/E 8.8x 9.4x 9.7x 8.5x

EBITDA (MM) 1,618.9 1,577.3 1,685.8 1,849.9

Prev. 1,550.8 1,698.5 1,847.6

Revenue (MM) 4,707.6 4,931.6 4,567.1 4,946.3

Prev. 4,803.4 4,782.0 5,080.4

EPS (Op) - FD Q1 Q2 Q3 Q4

2007 0.78A 1.12A 1.23A 1.20A

2008 0.75A 0.97A 1.20A 1.15A

Prev. 1.02E

2009 0.63E 0.90E 1.22E 1.20E

Prev. 0.72E 1.00E 1.31E 1.15E

2010 0.78E 1.04E 1.38E 1.32E

EBITDA (MM)

2007 343.1A 418.6A 431.6A 425.6A

2008 322.4A 384.3A 437.7A 432.9A

Prev. 406.4E

2009 336.5E 400.7E 477.4E 471.1E

Prev. 354.4E 419.8E 481.8E 442.5E

2010 380.5E 441.0E 521.3E 507.2E

Revenue (MM)

2007 1,115.9A 1,215.5A 1,187.9A 1,188.3A

2008 1,146.9A 1,220.3A 1,264.7A 1,299.7A

Prev. 1,171.5E

2009 1,045.2E 1,116.5E 1,159.8E 1,245.6E

Prev. 1,153.3E 1,189.7E 1,230.8E 1,208.2E

2010 1,136.7E 1,210.2E 1,257.3E 1,342.2E

All values in CAD unless otherwise noted.

For Required Disclosures, please see Page 12.

2

Q4/08 Better than Expected on Lower Tax and Fuel Surcharge; Equity Offering Raises $511MM

Results better than expected. CP reported Q4/08 operating EPS of $1.15, excluding the impact of foreign exchange on long-term debt and other specified items, which was above our estimate of $1.02 (consensus was $1.09) and down from last year’s $1.20. The main variance to our estimate was the fuel surcharge lag ($0.10 per share impact) and a lower tax rate ($0.04 per share impact). CP assumed control of the Dakota, Minnesota & Eastern Railroad (DM&E) at the end of October 2008, and results for the final two months of the year are consolidated on a line by line basis. The DM&E transaction contributed $0.18 to EPS net of both taxes and associated interest expense. We discuss the financial results in greater detail below and summarize the performance versus our forecasts in Exhibit 1.

Equity offering raises $511MM. Following the release of its Q4 results, CP also announced a bought deal equity offering of 13.9MM common shares (12.6MM plus 1.3MM green shoe) at a price of $36.75 per share for total proceeds of $510.8MM. While the offering was a surprise to us, we believe the underlying motivation was to firm up the balance sheet and protect the company’s investment grade rating of its debt, given the weak economic outlook and increased pension contribution requirements forecasted by the company for 2009 and 2010. We estimate the offering to be dilutive by 5% in 2009 and 7% in 2010 (see “Equity Offering” and “Estimates” section below for more details).

Revenue Increases Driven by Pricing, Fuel and Acquisition of DM&E

Q4/08 freight revenue increased 10% Y/Y to $1.26B from $1.14B in the prior year. This was above our forecast of $1.13B largely due to fuel surcharge lags. The 10% Y/Y increase consisted of:

Increases of:

• 5% in pricing

• 3% due to fuel surcharges

• 5% due to consolidation of the DM&E

• 9% due to foreign exchange

Decreases of:

• 10% in volume / mix

• 2% due to the CTA grain decision

Volumes were down across five of the seven commodity segments for a total decrease of 8% Y/Y (or 11% excluding DM&E). The most pronounced drop occurred in the December month, when carload volumes declined a significant 17% (exc. DM&E).

On the pricing front, CP achieved very robust renewals of 6% during the quarter and 5% for the full year.

Bulk:

• Grain: Revenue at $307.1MM increased by 8% Y/Y on an exchange adjusted basis, while volumes were up 4% Y/Y. Volumes were flat excluding the DM&E. Despite a retroactive adjustment in grain revenue entitlement, revenues were up Y/Y in the quarter due to strong volumes resulting from a strong crop in Canada as well as pricing gains, including seasonal pricing.

• Coal: Coal revenue at $139.5MM was up 3% Y/Y on an exchange adjusted basis. Contributing to the increase was price as well as the DM&E. Coal volumes were down 5% Y/Y in the quarter. For 2008, Teck coal volumes were up half as much as previously forecasted (previous forecast was an increase of 1 million tons) by management, mainly due to an unanticipated shut-down at one of the mines and a longer than expected holiday shut-down.

• Sulphur and Fertilizers: Revenue of $117.5MM was down 11% from last year on an exchange adjusted basis. Volumes were down 22% Y/Y. Impacting volumes were lower global demand and crop prices, in addition to the potash mine strike, which negatively affected the reported potash and chemical fertilizer volumes.

Merchandise & Intermodal:

• Intermodal. Intermodal revenue of $338.9MM was down 3% on a Y/Y exchange adjusted basis. The improvement in intermodal revenue is primarily due to price and fuel gains given that volumes were down 16% Y/Y.

• Automotive. Automotive revenues were down 7% from last year to $81.6MM despite a 21% decline Y/Y in volumes. Average revenue per car was up 46% due to key contract renewals, which improved price and fuel recovery, as well as mixed changes.

Canadian Pacific RailwayFebruary 11, 2009

3

• Forest Products. Continued weakness in the U.S. housing sector, as evidenced by lower housing starts, resulted in soft demand for lumber and wood panels, which resulted in revenue declining 22% Y/Y on an exchange adjusted basis to $57.2MM.

• Industrial and Consumer Products. Revenue increased 21% on a Y/Y basis to $216.0MM, although volumes were only up 1% Y/Y. This was due to additional volumes from the DM&E, growth in energy and fuel, as well as pricing strength.

Higher Operating Expenses Mostly Due to DM&E Acquisition Operating expenses increased 5% Y/Y to $995MM on an exchange adjusted basis with the operating ratio for the quarter at 76.5%, which was better than our forecast of 77.9% but a deterioration from the 74.3% reported in Q4/07. Operating expenses were driven up mainly due to foreign exchange as well as the inclusion of two months of DM&E expenses, partially offset by lower volumes as well as the company’s efficiency plan.

• Compensation and benefits costs were up 9% Y/Y on an exchange adjusted basis. Contributing to this increase was the DM&E as well as wage and benefit increases. Stock-based compensation also increased due primarily to the total return swap, but was partially offset by lower stock option expenses. CP implemented a series of temporary layoffs of crews and maintenance staff beginning late in the year. Headcounts were down 700 by quarter-end. At present, just over 1,000 employees, or about 10%, have been laid off, with about 1,450 at the peak.

• Fuel costs increased 6% on an exchange adjusted basis compared to last year, driven mostly by fuel hedges, as well as the contribution of DM&E. A one-time Minnesota tax credit in 2007 also increased expenses. Partially offsetting those increases were lower volumes and fuel prices, although refining margins were also up this quarter.

• Materials expense was down 10% Y/Y on an exchange adjusted basis to $45.9MM for the quarter, which reflects lower material usage across all areas of operations with major reductions for locomotives and freight car repairs.

• Equipment rents of $45.8MM were down 16% on an exchange adjusted basis compared to last year due to lower leasing costs resulting from reduced train starts and management of active car counts.

• Purchased services & other increased 6% on an exchange adjusted basis versus last year to $188.3MM primarily due to DM&E, as well as higher casualty costs. The impact of the company’s E3 initiatives contributed $3MM in lower expenses.


4

Exhibit 1: Actual versus Forecast

RBC CM

Q4/08E

RAIL STATS

Revenue ton-miles (RTM) 33,414 30,888 8.2% 32,540 2.7%

Freight revenue per RTM 3.76 3.65 3.1% 3.51 7.2%

Operating ratio 76.5% 77.9% -136bp 74.3% 225bp

OPERATING RESULTS ($MM)

Revenue

Freight revenue 1,257.8 1,128.0 11.5% 1,142.6 10.1% Positive impact of foreign exchange; pricing strength; fuel lag.

Other 41.9 43.4 n.a. 45.7 -8.3%

Total revenue 1,299.7 1,171.5 10.9% 1,188.3 9.4%

Expenses

Compensation 349.4 314.5 11.1% 308.4 13.3%

Fuel 239.5 217.1 10.3% 196.3 22.0%

Materials 45.9 44.6 2.9% 47.9 -4.2% Contribution of efficiency program.

Rents 45.8 45.0 1.8% 45.1 1.6%

Depreciation, amort. 125.9 120.5 4.5% 116.3 8.3%

Purchased services 188.3 177.8 5.9% 168.8 11.6%

Other - (7.1) n.a. -

Total operating expenses 994.8 912.5 9.0% 882.8 12.7%

Operating income 315.3 291.9 8.0% 305.5 3.2% $20MM variance attributed mainly to fuel surcharge lag effect.

Other charges (income) 8.3 6.0 38.3% (3.8) n.a.

Interest expense 73.8 65.3 13.0% 63.4 16.4%

Pretax income 233.2 220.6 5.7% 245.9 -5.2%

Taxes 54.9 61.8 -11.1% 60.8 nm

Effective tax rate 23.5% 28.0% 24.7% Significantly lower tax rate boosted earnings in Q4 and FY2008.

Forex on L-T debt and other (21.1) (21.1) n.a. 139.4

Net income 200.6 158.8 26.3% 342.3 -41.4%

EPS operating ($) 1.15 1.02 12.3% 1.20 -3.9%

EPS net ($) 1.29 1.02 26.4% 2.21 -41.5%

Q4/08A Var (%)

Y/Y chg

(%) NotesQ4/07A

Source: Company reports and RBC CM estimates

2009 Outlook: A Challenging Year Ahead

Pricing Expected to Hold Steady

Average contract renewals were up 6% for Q4 and 5% for the full year 2008, in line with management expectations. According to management, over 60% of their book of business was priced as of the end of the year, excluding the Teck Cominco metallurgical coal contract. This is below the average 2009 book of business prices for its peer group (the average is 64%, excluding CP). In terms of contracts, at the present time, over 80% of contracts have now been negotiated for 2009.

Volumes Expected to Be Mostly Down

• Grain: Canadian grain production is estimated at 54 million metric tons for the current crop year, which is up 4% from earlier projections. In the U.S., there are near-record crops.


5

• Coal: Teck recently announced an expected reduction of its overall 2009 production (see our January 8th Research Comment). Negotiations continue around the April 1st contract renewal.

• Sulphur and Fertilizers: The market still appears to be slow for the first half of 2009; however, management expects to capture the anticipated recovery of potash in the balance of the year.

• Forest Products: Management expects continued uncertainty in the sector for 2009.

• Industrial and Consumer Products: Future sector growth remains uncertain due to the decline in oil prices, as well as falling commercial construction.

• Automotive: Management expects to see continued weakness in 2009 as recent U.S. auto sales point below 11 million.

• Intermodal: According to management, the intermodal segment is expected to suffer further volume declines in 2009 since GDP forecasts for this year are lower. The size of the increase is unclear given there is uncertainty regarding the retail sales outlook for the year.

Right-Sizing Efforts Under Way on Lower Expected Volumes • Compensation and Benefis: The full impact of the employee layoffs were not fully reflected in Q4/08. Therefore, the

impact of these measures is expected to be reflected in Q1/09.

• Train costs: To mirror the impact of declining volumes, CP has stored over 270 of its locomotives (representing 15% of its fleet). In addition, over 15,000 railcars (about 20% of its fleet) have also been stored. The impact of these measures is expected to manifest in early 2009.

• Lower capex: As previously announced, CP will be lowering its capex budget in 2009 in response to the slowdown in economic activity. CP’s capital investment for 2009 is expected to fall in the range of $800MM-$820MM, which is $200MM lower than the 2008 total comprised of both CP and DM&E cash capital investments. Average currency exchange is assumed to be C$1.25 per U.S. dollar (US$0.80 per Canadian dollar).

Pension Contributions to Increase; Equity Offer Mitigates Impact Significant decline in pension fund assets assuming January 1, 2009 filing. The rapid declines in the equity markets and Government of Canada bond yields have resulted in a significant pension fund shortfall (97% of CP’s pension plan is on defined benefit). If CP were to file a valuation as at January 1, 2009, CP estimates that its pension plan assets will have fallen 20% to $6.0B, from $7.6B on January 1, 2008. This is against estimated solvency liabilities of $7.6B, implying a deficit of $1.6B.

Drop in plan value increases contribution requirements. Based on preliminary calculations, CP expects that aggregate contributions to all of its defined benefit pension plans will increase from $95MM in 2008 to a range of $150MM-$195MM for 2009. For 2010, the company estimates its minimum required contributions to be approximately $295MM-$345MM. (For accounting purposes, however, management does not expect pension expense in 2009 to increase materially from 2008 levels). The lower end of the contribution ranges provided are based on the federal government providing temporary funding relief while the upper ends do not include any funding relief.

Contribution requirements would have put pressure on debt ratings – $510MM equity offering relieves pressure. Given that CP’s 2008 free cash flow (after dividends) was $232MM, and given 1) the potential pressure on FCF in today’s economic environment, and 2) the magnitude of the 2009 and 2010 expected pension fund contribution requirements as compared to FCF generation, we believe there was a risk of a debt rating downgrade. As shown in Exhibit 2, CP’s debt is currently only one notch above non-investment grade as per Moody’s and two notches above as per DBRS and S&P (although both have CP on credit watch negative). In the event of a rating downgrade, CP’s cost of capital would have been negatively impacted. Further, today’s skittish markets have proven that companies with even the slightest indication of balance sheet issues have had significant downward pressure on share prices. However, with the $510MM equity offering – and judging by the language of the rating agencies’ releases following the offering – we believe CP has successfully averted downward ratings adjustments to its debt and has avoided negative pressure on its share price associated with potential/perceived balance sheet concerns.

Exhibit 2: CP Debt Ratings

Credit Rating Outlook Notches > Investment Grade

DBRS BBB Negative 2

Moody's Baa3 Stable 1

S&P BBB Negative 2

Source: DBRS, Moody’s; S&P, RBC Capital Markets estimates


6

Sensitivity analysis. The estimates outlined by management above are based on: 1) Canada bond yields of 4% at December 31, 2009; and 2) the assumption of a 10% return in 2009 in the company’s pension plan investments in public equities, real estate and infrastructure. The cash requirements would increase by $30MM if long Canada bond yields were 3.5% (instead of 4%) or by $40MM if investment returns were 5% (instead of 10%).

Reducing Estimates on Lower Expected Volumes and Dilutive Impact of Equity Offering

Not surprisingly, management did not provide firm guidance for 2009. We are making a number of adjustments to our forecasts and volume assumptions, as well as accounting for the dilutive effect of the equity offering. The net effect is a reduction to EPS in 2009 to $3.95 (from $4.18) and in 2010 to $4.52 (from $4.79). Details of our forecasts and assumptions are as follows:

• Lowering volume for economically sensitive segments. We are forecasting overall volume declines of 6.5% to 7.0% in H1/09 and 4%-5% in H2/09, for an average 2009 volume decline of 5.5% as measured on an RTM basis (Exhibit 3). This is a reduction compared to our prior 2009 assumption of a 2.3% volume decline.

• Lowering assumptions for Teck Coal. Based on guidance provided by Teck for 20MMT coal production in 2009 (vs. 23MMT estimated in 2008), we are now assuming a 10% decline in coal volumes for CP in 2009 (from our previous assumption of a 2% decline).

• Foreign exchange to be a modest offset. We are lowering our $CAD exchange rate assumption to US$0.80/$CAD in 2009 and US$0.87 in 2010 (from $0.88 in both years). On average, every $0.01 change in forex results in a $0.01 change in EPS. As a result, our forex adjustment is estimated to have a $0.08 beneficial impact in 2009.

• Fuel costs down significantly. Another mitigating factor (common to all the railroads) is the significant reduction to our fuel cost assumption. We are now assuming WTI of $55/barrel in 2009 and $70/barrel in 2010 – a significant reduction to our prior assumption of $80/barrel in both years.

• Equity offering dilution estimated at 5% in 2009, 7% in 2010. We have assumed that the use of proceeds is driven mainly toward debt reduction. Accordingly, we estimate the 2009 dilution from the equity offering (assuming over-allotment is exercised) at $0.20 (5%) in 2009 and $0.33 (7%) in 2010.

Exhibit 3: Breakdown of 2009E Volume Assumptions

% of Revenue % Growth year-over-year

(2008E) 2008E 2009E

Volume New Old Note

Grain 20% -5.2% 0.4% -0.4% Impacted in 2008 by late harvest; assuming push forward into 2009.

Coal 13% 5.9% -10.0% -1.8% Assuming a 2MMt decline at Elk Valley.

Sulphur & Fertilizers 11% -0.4% -1.8% 0.7% Negative growth despite very easy comps (potash strike in '08).

Forest products 5% -20.3% -5.0% -5.0% Continued declines expected as per our Forestry Products research.

Industrial & Consumer Products 16% 12.4% -8.0% -4.5% Driven by lower activity in Energy sector.

Automotive 7% -8.0% -17.9% -11.1% Double digit declines consistent with Auto sector expectations.

Intermodal 29% -3.8% -8.5% -4.3% Material intermodal declines on weak transpacific trade.

Total 100% -1.0% -5.5% -2.3%

Pric ing (exc. fuel and forex) 4%-6% 2.3% 2.6% Driven by flat price growth assumption for Teck Coal; 4% for remaining.

EPS $4.06 $3.95 $4.18

Source: RBC CM estimates


7

Exhibit 4: Estimate Revisions

2007 2008 RBC CM 2009E RBC CM 2010E Y/Y Change (%)

Actual Actual Old New Var (%) Old New Var (%) 2007 2008 2009E 2010E

Revenue 4,708 4,932 4,782 4,567 -4.5% 5,080 4,946 -2.6% 2.7% 4.8% -7.4% 8.3%

Expenses 3,543 3,874 3,693 3,437 -6.9% 3,861 3,683 -4.6% 2.6% 9.3% -11.3% 7.1%

Operating ratio 75.3% 78.6% 77.2% 75.3% -197bp 76.0% 74.5% -155bp -11bp 329bp -330bp -81bp

Operating income 1,164 1,109 1,208 1,210 0.2% 1,338 1,364 1.9% 3.2% -4.8% 9.1% 12.7%

Interest 204 261 264 266 0.6% 260 248 -4.8% 5.0% 27.8% 1.8% -6.8%

Tax 270 193 271 258 -5.1% 311 317 1.8% -3.2% -28.4% 33.3% 22.9%

Tax rate 28.6% 23.4% 29.5% 28.0% -150bp 29.5% 29.0% -50bp -214bp -520bp 458bp 100bp

Other 17 23 24 24 0.0% 24 24 0.0% -37.8% 31.2% 5.7% 0.0%

Net income 673 632 648 662 2.2% $743.00 775 4.3% 7.2% -6.1% 4.8% 17.0%

Operating EPS (f.d.) $4.32 $4.06 $4.18 $3.95 -5.6% $4.79 $4.52 -5.6% 9.5% -6.0% -2.8% 14.6%

Source: RBC CM estimates


8

Valuation

Our price target is based on a 13x P/E multiple (applied to our 2009 estimate), which reflects the current economic environment but islower than our target multiple for the other railroad companies in our coverage universe due to what will likely be a discount applied toCP shares given the lack of execution in 2008 and potential financing risk associated with the PRB project. We rate CP shares SectorPerform, Average Risk.

Price Target Impediment

Impediments to achieving our estimates and price target include extreme fluctuations in fuel prices, unusual weather conditions thatcould impact grain crops or railway operating efficiencies, and a weaker economic recovery than currently envisioned.

Company DescriptionCanadian Pacific Railway operates over a 14,000-mile rail network extending from Montreal to Vancouver and throughout the U.S.Midwest and Northeast. Commercial alliances with other railways extend CPR's market reach beyond its own network. In the west, CPRis an efficient transporter of bulk commodities to exports markets while also moving merchandise and autos throughout North America.


9

Appendix 1: Rail Comparables

RBC CM Research Shares Mkt Net

Invest Risk 12-Mo Implied Price O/S Cap EV Debt EBITDA ($MM) EPS EV/EBITDA P/E

Sym. Rating4 Rating5 Target Return ($/sh) (MM) ($MM) ($MM) /EV 2007 2008E 2009E 2010E 2007 2008E 2009E 2010E 2007 2008E 2009E 2010E Yld 2007 2008E 2009E 2010E

Canadian Rails 1

Canadian National Railway CNR O Avg 53.00 20% 44.92 465 20,883 28,381 26% 3,553 3,619 3,680 4,007 3.40 3.70 3.76 4.31 8.0x 7.8x 7.7x 7.1x 2.2% 13.2x 12.1x 12.0x 10.4x

Canadian Pacific Railway CP SP Avg 51.00 36% 38.20 155 5,921 10,533 44% 1,619 1,577 1,686 1,850 4.32 4.06 3.95 4.52 6.5x 6.7x 6.2x 5.7x 2.6% 8.8x 9.4x 9.7x 8.4x

Average 7.2x 7.3x 7.0x 6.4x 2.4% 11.0x 10.8x 10.8x 9.4x

U.S. Rails (Class 1) 2,3

Burlington Northern BNI U Avg 81.00 19% 69.57 348 24,196 32,662 26% 4,860 5,497 5,341 5,811 5.24 6.33 6.00 7.00 6.7x 5.9x 6.1x 5.6x 2.3% 13.3x 11.0x 11.6x 9.9x

CSX Corp. CSX O Avg 51.00 69% 30.71 396 12,151 19,237 37% 3,206 3,713 3,629 4,026 2.70 3.51 3.65 4.53 6.0x 5.2x 5.3x 4.8x 2.9% 11.4x 8.8x 8.4x 6.8x

Kansas City Southern KSU n.r. n.r. n.r. n/a 19.64 91 1,793 3,606 50% 530 559 555 623 1.61 1.78 1.70 2.09 6.8x 6.5x 6.5x 5.8x 0.0% 12.2x 11.0x 11.6x 9.4x

Norfolk Southern NSC SP Avg 61.00 62% 38.40 372 14,300 20,349 30% 3,453 4,010 3,908 4,100 3.73 4.54 4.50 5.00 5.9x 5.1x 5.2x 5.0x 3.5% 10.3x 8.5x 8.5x 7.7x

Union Pacific UNP SP Avg 64.00 39% 46.77 507 23,689 31,367 24% 4,812 5,554 5,474 5,919 3.51 4.48 4.55 5.21 6.5x 5.6x 5.7x 5.3x 2.3% 13.3x 10.4x 10.3x 9.0x

Average (exc. KSU) 6.3x 5.5x 5.6x 5.2x 2.8% 12.1x 9.7x 9.7x 8.3x

U.S. Rails (Class 2) 2,3

Genesee & Wyoming GWR n.r. n.r. n.r. n/a 28.24 36 1,017 1,295 21% 122 158 182 208 1.54 1.76 2.11 2.42 10.6x 8.2x 7.1x 6.2x 0.0% 18.3x 16.0x 13.4x 11.7x

1 CAD

2 USD

3 First call estimates for KSU and GWR

4 Investment ratings: TP (Top Pick); O (Outperform); SP (Sector Perform); U (Underperform); n.r. (not rated)

5 Risk ratings: Avg (Average); AA (Above Average); S (Speculative) Source: Company reports, RBC CM


10

Appendix 2: Price Target Impediments and Justifications

Company (Symbol) Valuation Target Price Impediments

BNSF Railway

(NYSE: BNI)

Our target price is based on a P/E multiple of 13.5x, which is reflective of the current economic environment but is

also lower than our target multiple for the other railroad companies in our coverage universe, reflective of what will

likely be a discount applied to BNI shares given the higher exposure to economically sensitive Intermodal (33%) and

Industrial Products (23%) segments.

Impediments to achieving our estimates and price target include extreme fluctuations in fuel prices,

unusual weather conditions that could impact on grain crops or on railway operating efficiencies

and weaker economic conditions than currently envisioned.

CN Railway

(TSX: CNR; NYSE: CNI)

Our 14x multiple (applied to our 2009 estimates) is reflective of the current economic environment, but is above the

target multiple we use for the other railroad companies in our coverage universe, reflective of what we consider in

CNR to be a "flight to quality" phenomenon. We believe CNR's strong relative operating performance will result in

more limited downside compared to its peer group – and this should translate into a premium multiple.



and weaker economic conditions than currently envisioned.

CP Railway

(TSX: CP, NYSE: CP)

Our price target is based on a 13x P/E multiple (applied to 2009 estimates), which is reflective of the current

economic environment, but is also lower than our target multiple for the other railroad companies in our coverage

universe, reflective of what will likely be a discount applied to CP shares given the lack of execution in 2008 and

potential financing risk associated with the PRB project.


unusual weather conditions that could impact grain crops or railway operating efficiencies, and a

weaker economic recovery than currently envisioned.

CSX Corporation

(NYSE: CSX)

Our 14x multiple (applied to 2009 estimates) which is between the mid- to higher end of the Class 1 railroad's

historical trading band, reflective of: 1) our view that the strong industry fundamentals will lead to an upward shift in

the historical trading band for the Class 1 railroads; 2) CSX's relatively defensive business mix; 3) expectation of a

more pronounced upward revision in CSX’s multiple in the event of an economic turnaround; and 4) upside from

potential productivity improvements.



and a weaker economic recovery than currently envisioned.

Norfolk Southern Corporation

(NYSE: NSC)

Our 13.5x multiple (applied to 2009 estimates) which is between the mid- to higher end of the Class 1 railroad's


the historical trading band for the Class 1 railroads and 2) NSC’s being an efficient rail operator.




Union Pacific Corporation

(NYSE: UNP)

Our 14x multiple (applied to 2009 estimates) which is between the mid- to higher end of the Class 1 railroad's


the historical trading band for the Class 1 railroads and 2) UNP's potential for margin expansion over the long-term.




Source: RBC CM


11

CP Rail Year-Over-Year Change

($MM unless otherwise indicated) 2006 2007 Q1/08 Q2/08 Q3/08 Q4/08 2008 Q1/09E Q2/09E Q3/09E Q4/09E 2009E 2010E 2006 2007 2008 2009E 2010E

INCOME STATEMENT

Revenue 4,583 4,708 1,147 1,220 1,265 1,299.7 4,931.6 1,045.2 1,116.5 1,159.8 1,245.6 4,567.1 4,946.3 4.4% 2.7% 4.8% -7.4% 8.3%

Total Operating Expenses 3,455 3,543 949 969 962 995 3,874 848 855 821 914 3,437 3,683 1.9% 2.6% 9.3% -11.3% 7.1%

Operating ratio 75.4% 75.3% 82.7% 79.4% 76.0% 76.5% 78.6% 81.1% 76.6% 70.8% 73.3% 75.3% 74.5% -182bp -11bp 329bp -330bp -81bp

Operating income 1,129 1,164 209 265 320 315 1,109 217 282 358 352 1,210 1,364 12.7% 3.2% -4.8% 9.1% 12.7%

Income from continuing ops. 628 673 116 150 187 178 632 102 151 207 202 662 775 18.8% 7.2% -6.1% 4.8% 17.0%

Net Income 796 946 91 155 173 201 619 102 151 207 202 662 775 46.8% 18.8% -34.6% 7.0% 17.0%

EPS, operating (fully diluted) - $ 3.95 4.32 0.75 0.97 1.20 1.15 4.06 0.63 0.90 1.22 1.20 3.95 4.52 19.7% 9.5% -6.0% -2.8% 14.6%

EPS, net (fully diluted) - $ 5.00 6.09 0.59 1.00 1.11 1.29 3.99 0.63 0.90 1.22 1.20 3.95 4.52 47.2% 21.7% -34.4% -1.1% 14.6%

Avg. shares outstanding (fully diluted) 159 156 155 155 155 155 156 162 169 169 169 167 171 -0.4% -2.2% -0.1% 7.5% 5.8%

EBITDA 1,565 1,619 322 384 438 432.9 1,577.3 336.5 400.7 477.4 471.1 1,685.8 1,849.9 9.6% 3.5% -2.6% 6.9% 449.8%

BALANCE SHEET

Cash and short-term investments 124 378 71 81 98 118 118 187 215 306 400 400 136 2.1% 204.1% -68.9% 239.9% -27.2%

Other current assets 881 790 833 948 1,038 1,005 1,005 711 754 781 833 833 892 14.1% -10.3% 27.3% -17.2% 25.4%

Current assets 1,005 1,168 904 1,028 1,136 1,123 1,123 898 970 1,087 1,233 1,233 1,028 12.4% 16.2% -3.8% 9.8% 14.4%

Net properties 9,123 9,293 9,360 9,464 9,629 12,577 12,577 12,652 12,727 12,802 12,877 12,877 13,267 3.8% 1.9% 35.3% 2.4% 4.9%

Other assets 2,293 4,072 4,015 4,214 4,421 2,893 2,893 2,672 2,748 2,870 3,021 3,021 2,833 9.2% 77.6% -29.0% 4.4% 6.0%

Total assets 11,416 13,365 13,375 13,678 14,050 15,470 15,470 15,324 15,475 15,672 15,898 15,898 16,100 4.8% 17.1% 15.7% 2.8% 5.1%

Total debt 3,005 4,407 4,365 4,510 4,669 4,880 4,880 4,380 4,370 4,360 4,350 4,350 4,000 0.1% 46.7% 10.7% -10.9% -8.7%

Total liabilities 3,555 3,500 3,479 3,502 3,576 4,597 4,597 4,423 4,500 4,567 4,667 4,667 4,868 1.4% -1.5% 31.3% 1.5% 10.1%

Shareholders' equity 4,857 5,458 5,531 5,666 5,805 5,993 5,993 6,566 6,676 6,841 7,001 7,001 7,603 10.7% 12.4% 9.8% 16.8% 15.8%

Total liabilities and shareholders' equity 11,416 13,365 13,375 13,678 14,050 15,470 15,470 15,370 15,546 15,767 16,018 16,018 16,471 4.8% 17.1% 15.7% 3.5% 7.2%

CASH FLOW SUMMARY

Free cash flow (before dividends) 357.3 436.5 (104.6) (112.2) 37.2 415.6 380.7 4.6 65.1 133.3 127.8 330.9 239.3 96.9% 22.2% -12.8% -13.1% -27.7%

Dividends (112.4) (133.1) (34.5) (38.0) (38.1) (38.1) (148.7) (40.1) (41.8) (41.8) (41.8) (165.5) (173.5) 25.6% 18.4% 11.7% 11.3% 4.8%

Free cash flow (after dividends) 244.9 303.4 (139.1) (150.2) (0.9) 377.5 232.0 (35.5) 23.3 91.5 86.0 165.4 65.8 166% 23.9% -23.5% -28.7% -60.2%

Cashflow from investing activities (694) (2,514) (271) (296) (246) (42) (856) (200) (200) (200) (200) (800) (900) -20.2% 262.4% -66.0% -6.6% 350.0%

Cashflow from financing activities (354.80) 1,453.50 (195.90) 123.00 (19.40) (395.90) (488.20) (49.69) (51.80) (51.80) (51.80) (205.10) (523.49) -14.0% -509.7% -133.6% -58.0% 953.5%

Source: Company reports, RBC CM Estimates


12

Required Disclosures

This product constitutes a compendium report (covers six or more subject companies). As such, RBC Capital Markets chooses toprovide specific disclosures for the subject companies by reference. To access current disclosures for the subject companies, clientsshould refer to http://www7.rbccm.com/GLDisclosure/PublicWeb/DisclosureLookup.aspx?EntityID=1 or send a request to RBC CMResearch Publishing, P.O. Box 50, 200 Bay Street, Royal Bank Plaza, 29th Floor, South Tower, Toronto, Ontario M5J 2W7.

Distribution of Ratings

For the purpose of ratings distributions, regulatory rules require member firms to assign ratings to one of three rating categories - Buy,Hold/Neutral, or Sell - regardless of a firm's own rating categories. Although RBC Capital Markets' ratings of Top Pick/Outperform,Sector Perform and Underperform most closely correspond to Buy, Hold/Neutral and Sell, respectively, the meanings are not the samebecause our ratings are determined on a relative basis (as described above).

Distribution of RatingsRBC Capital Markets, Equity Research

Investment BankingServ./Past 12 Mos.

Rating Count Percent Count Percent

BUY[TP/O] 502 44.90 115 22.91HOLD[SP] 508 45.40 88 17.32SELL[U] 108 9.70 12 11.11

Analyst Certification

All of the views expressed in this report accurately reflect the personal views of the responsible analyst(s) about any and all of thesubject securities or issuers. No part of the compensation of the responsible analyst(s) named herein is, or will be, directly orindirectly, related to the specific recommendations or views expressed by the responsible analyst(s) in this report.

Dissemination of Research

RBC Capital Markets endeavours to make all reasonable efforts to provide research simultaneously to all eligible clients, havingregard to local time zones in overseas jurisdictions. RBC Capital Markets' research is posted to our proprietary websites to ensureeligible clients receive coverage initiations and changes in rating, targets and opinions in a timely manner. Additional distribution maybe done by the sales personnel via email, fax or regular mail. Clients may also receive our research via third party vendors. Pleasecontact your investment advisor or institutional salesperson for more information regarding RBC Capital Markets research.RBC Capital Markets also provides eligible clients with access to a database which may contain Short-Term trading calls on certain ofthe subject companies for which it currently provides equity research coverage. The database may be accessed via the followinghyperlink https://www2.rbccm.com/cmonline/index.html. The information regarding Short-Term trading calls accessible through thedatabase does not constitute a research report. These Short-Term trading calls are not formal ratings and reflect the research analyst'sviews with respect to market and trading events in the coming days or weeks and, as such, may differ from the price targets andrecommendations in our published research reports reflecting the research analyst's views of the longer-term (one year) prospects ofthe subject company. Thus, it is possible that a subject company's common equity that is considered a long-term 'sector perform' oreven an 'underperform' might be a Short-Term buying opportunity as a result of temporary selling pressure in the market; conversely, asubject company's common equity rated a long-term 'outperform' could be considered susceptible to a Short-Term downward pricecorrection.

Conflicts Disclosures

RBC Capital Markets Policy for Managing Conflicts of Interest in Relation to Investment Research is available from us on request. Toaccess our current policy, clients should refer tohttp://www.rbccm.com/cm/file/0,,63022,00.pdfor send a request to RBC CM Research Publishing, P.O. Box 50, 200 Bay Street, Royal Bank Plaza, 29th Floor, South Tower,Toronto, Ontario M5J 2W7. We reserve the right to amend or supplement this policy at any time.

Important Disclosures

The analyst(s) responsible for preparing this research report received compensation that is based upon various factors, including totalrevenues of the member companies of RBC Capital Markets and its affiliates, a portion of which are or have been generated byinvestment banking activities of the member companies of RBC Capital Markets and its affiliates.


http://www7.rbccm.com/GLDisclosure/PublicWeb/DisclosureLookup.aspx?EntityID=1

https://www2.rbccm.com/cmonline/index.html

13

Additional DisclosuresRBC Capital Markets is the business name used by certain subsidiaries of Royal Bank of Canada, including RBC Dominion Securities Inc., RBC Capital MarketsCorporation, Royal Bank of Canada Europe Limited and Royal Bank of Canada - Sydney Branch. The information contained in this report has been compiled by RBCCapital Markets from sources believed to be reliable, but no representation or warranty, express or implied, is made by Royal Bank of Canada, RBC Capital Markets, itsaffiliates or any other person as to its accuracy, completeness or correctness. All opinions and estimates contained in this report constitute RBC Capital Markets'judgement as of the date of this report, are subject to change without notice and are provided in good faith but without legal responsibility. Nothing in this reportconstitutes legal, accounting or tax advice or individually tailored investment advice. This material is prepared for general circulation to clients and has been preparedwithout regard to the individual financial circumstances and objectives of persons who receive it. The investments or services contained in this report may not be suitablefor you and it is recommended that you consult an independent investment advisor if you are in doubt about the suitability of such investments or services. This report isnot an offer to sell or a solicitation of an offer to buy any securities. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss oforiginal capital may occur. RBC Capital Markets research analyst compensation is based in part on the overall profitability of RBC Capital Markets, which includesprofits attributable to investment banking revenues. Every province in Canada, state in the U.S., and most countries throughout the world have their own laws regulatingthe types of securities and other investment products which may be offered to their residents, as well as the process for doing so. As a result, the securities discussed in thisreport may not be eligible for sale in some jurisdictions. This report is not, and under no circumstances should be construed as, a solicitation to act as securities broker ordealer in any jurisdiction by any person or company that is not legally permitted to carry on the business of a securities broker or dealer in that jurisdiction. To the fullextent permitted by law neither RBC Capital Markets nor any of its affiliates, nor any other person, accepts any liability whatsoever for any direct or consequential lossarising from any use of this report or the information contained herein. No matter contained in this document may be reproduced or copied by any means without the priorconsent of RBC Capital Markets.

Additional information is available on request.

To U.S. Residents:This publication has been approved by RBC Capital Markets Corporation, which is a U.S. registered broker-dealer and which accepts responsibility for this report and itsdissemination in the United States. Any U.S. recipient of this report that is not a registered broker-dealer or a bank acting in a broker or dealer capacity and that wishesfurther information regarding, or to effect any transaction in, any of the securities discussed in this report, should contact and place orders with RBC Capital MarketsCorporation.To Canadian Residents:This publication has been approved by RBC Dominion Securities Inc. Any Canadian recipient of this report that is not a Designated Institution in Ontario, an AccreditedInvestor in British Columbia or Alberta or a Sophisticated Purchaser in Quebec (or similar permitted purchaser in any other province) and that wishes further informationregarding, or to effect any transaction in, any of the securities discussed in this report should contact and place orders with RBC Dominion Securities Inc., which, withoutin any way limiting the foregoing, accepts responsibility for this report and its dissemination in Canada.To U.K. Residents:This publication has been approved by Royal Bank of Canada Europe Limited ('RBCEL') which is authorized and regulated by Financial ServicesAuthority ('FSA'), inconnection with its distribution in the United Kingdom. This material is not for general distribution in the United Kingdom to retail clients, as defined under the rules ofthe FSA. However, targeted distribution may be made to selected retail clients of RBC and its affiliates. RBCEL accepts responsibility for this report and its disseminationin the United Kingdom.To Persons Receiving This Advice in Australia:This material has been distributed in Australia by Royal Bank of Canada - Sydney Branch (ABN 86 076 940 880, AFSL No. 246521). This material has been prepared forgeneral circulation and does not take into account the objectives, financial situation or needs of any recipient. Accordingly, any recipient should, before acting on thismaterial, consider the appropriateness of this material having regard to their objectives, financial situation and needs. If this material relates to the acquisition or possibleacquisition of a particular financial product, a recipient in Australia should obtain any relevant disclosure document prepared in respect of that product and consider thatdocument before making any decision about whether to acquire the product.To Hong Kong Residents:This publication is distributed in Hong Kong by RBC Investment Services (Asia) Limited, a licensed corporation under the Securities and Futures Ordinance or, by RoyalBank of Canada, Hong Kong Branch, a registered institution under the Securities and Futures Ordinance. This material has been prepared for general circulation and doesnot take into account the objectives, financial situation, or needs of any recipient. Hong Kong persons wishing to obtain further information on any of the securitiesmentioned in this publication should contact RBC Investment Services (Asia) Limited or Royal Bank of Canada, Hong Kong Branch at 17/Floor, Cheung Kong Center, 2Queen's Road Central, Hong Kong (telephone number is 2848-1388).To Singapore Residents:This publication is distributed in Singapore by RBC (Singapore Branch), a registered entity granted offshore bank status by the Monetary Authority of Singapore. Thismaterial has been prepared for general circulation and does not take into account the objectives, financial situation, or needs of any recipient. You are advised to seekindependent advice from a financial adviser before purchasing any product. If you do not obtain independent advice, you should consider whether the product is suitablefor you. Past performance is not indicative of future performance.

®Registered trademark of Royal Bank of Canada. RBC Capital Markets is a trademark of Royal Bank of Canada. Used under license.Copyright © RBC Capital Markets Corporation 2009 - Member SIPC

Copyright © RBC Dominion Securities Inc. 2009 - Member CIPFCopyright © Royal Bank of Canada Europe Limited 2009

Copyright © Royal Bank of Canada 2009All rights reserved


Documents

Canadian Pacific - RBC