Canadian Pacific Railway Limited

January 28, 2015 Canadian Pacific Railway Limited (CP-NYSE) Current Recommendation Analyst Note SUMMARY DATA NEUTRAL Prior Recommendation Outperform Date of Last Change 05/27/2013 Current Price (01/27/15) $179.40 Target Price $188.00 52-Week High $214.82 52-Week Low $141.60 One-Year Return (%) 27.15 Beta 1.32 Average Daily Volume (sh) 1,175,001 Shares Outstanding (mil) 171 Market Capitalization ($mil) $30,677 Short Interest Ratio (days) 4.78 Institutional Ownership (%) 75 Insider Ownership (%) 0 SUMMARY Canadian Pacific Railway reported lower than expected earnings in the fourth quarter of 2014. Adjusted earnings per share of $2.20 missed the Zacks Consensus Estimate of $2.28. Quarterly revenues climbed 9.5% year over year to C$1,760 million ($1,550 million). The demand for rail services remained healthy across most business segments translating into strong year-over-year growth. The company expects operating ratio for fiscal 2015 to remain below 62% while revenues are likely to expand between 7% and 8%. Likewise, adjusted earnings per share for the fiscal are projected to rise over 25% year over year. We believe that the end of merger talks with CSX Corp. is a vital blow to the company as the deal would have helped it counter competition. Moreover, labor issues and commodity risks may further impede growth. We, thus, maintain our Neutral recommendation on Canadian Pacific. Our target price is $188 per share. Risk Level * Average Type of Stock Large-Growth Industry Trans-Rail Zacks Industry Rank * 190 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) Annual Cash Dividend $1.23 Dividend Yield (%) 0.68 5-Yr. Historical Growth Rates Sales (%) 6.7 Earnings Per Share (%) 22.1 Dividend (%) 5.9 using TTM EPS 23.9 using 2015 Estimate 20.0 using 2016 Estimate 16.9 2013 1,456 A 1,455 A 1,486 A 1,445 A 5,513 A 2014 1,369 A 1,562 A 1,481 A 1,550 A 5,446 A 2015 1,381 E 1,455 E 1,468 E 1,554 E 6,178 E 2016 6,534 E Earnings Per Share Estimates (EPS is operating earnings before non-recurring items, but including employee stock options expenses) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2013 $1.21 A $1.39 A $1.82 A $1.72 A $5.77 A 2014 $1.31 A $1.96 A $2.04 A $2.20 A $6.99 A 2015 $1.82 E $2.23 E $2.34 E $2.57 E $8.96 E 2016 $10.61 E Zacks Rank *: Short Term 1 3 months outlook 4 - Sell Projected EPS Growth - Next 5 Years % 14 * Definition / Disclosure on last page 2015Zacks Investment Research, All Rights reserved. www.zacks.com 10 S. Riverside Plaza, Chicago IL 60606

RECENT NEWS Q4 Earnings Miss at Canadian Pacific Jan 22,2015 Canadian Pacific reported earnings per share of C$2.63 (approximately $2.32) in the fourth quarter of 2014 against 47 cents recorded in the year-ago quarter. However, adjusted earnings per share of $2.20 missed the Zacks Consensus Estimate of $2.28. Quarterly revenues climbed 9.5% year over year to C$1,760 million ($1,550 million), which also outpaced the Zacks Consensus Estimate of $1,512 million. The demand for rail services remained healthy across most business segments translating into strong year-over-year growth. In the fourth quarter, carloads (volume) increased 4% year over year and revenue ton-miles. Operating income witnessed record improvement of 521% year over year to C$708 million on higher shipments, cost efficiency, increased freight rates, lower pension expenses and favorable exchange rates. Operating expenses fell 29.5% year over year owing to lower incentive compensation and assets impairment charges. Operating ratio (defined as operating expenses as a percentage of revenues) improved a whopping 310 basis points year over year to 61.2% on continued focus on maintaining asset efficiencies, safety measures and productivity increase. Liquidity Canadian Pacific exited the fourth quarter with cash and cash equivalents of C$226 million against C$476 million at the end of fiscal 2013. Long-term debt was C$5,659 million against C$4,687 million at end-2013. Outlook The company expects operating ratio for full-year fiscal 2015 to remain below 62% while revenues are likely to expand between 7% and 8%. Adjusted earnings per share for the fiscal are projected to rise over 25% year over year. VALUATION Canadian Pacific is currently trading at 20.0x our fiscal 2015 earnings estimate. This is at a premium to both the industry average and the S&P 500. With respect to our fiscal 2016 earnings estimate, the stock is trading at 16.9x, again a premium to both the industry average and the S&P 500. We continue to have a Neutral recommendation with the target price of $188, based on 21.0x our earnings estimate for 2015. Equity Research CP Page 2

Key Indicators F1 F2 Est. 5-Yr EPS Gr% P/CF 5-Yr High 5-Yr Low Canadian Pacific Railway Limited (CP) 20.0 16.9 14.0 17.8 23.9 29.5 15.2 Industry Average 17.2 15.1 12.8 28.1 19.9 51.2 14.4 S&P 500 16.2 15.1 10.7 16.1 18.6 19.4 12.0 Canadian National Railway Company (CNI) 18.7 16.4 13.1 17.5 20.2 23.4 14.3 Norfolk Southern Corporation (NSC) 14.8 13.5 12.1 10.9 16.3 20.0 11.1 Kansas City Southern (KSU) 20.2 17.7 15.6 15.2 22.7 54.4 18.6 Guangshen Railway Co. Ltd. (GSH) 8.1 23.1 22.1 8.9 TTM is trailing 12 months; F1 is 2015 and F2 is 2016, CF is operating cash flow P/B Last Qtr. P/B 5-Yr High P/B 5-Yr Low ROE D/E Last Qtr. Div Yield Last Qtr. EV/EBITDA Canadian Pacific Railway Limited (CP) 4.9 5.4 1.3 18.6 1.0 0.6 13.7 Industry Average 4.0 4.0 4.0 12.3 0.4 1.0 16.4 S&P 500 5.1 9.8 3.2 24.8 2.0 Equity Research CP Page 3

Earnings Surprise and Estimate Revision History Equity Research CP Page 4

DISCLOSURES & DEFINITIONS OVERVIEW The analysts contributing to this report do not hold any shares of CP. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will underperform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1127 companies covered: Outperform - 15.8%, Neutral - 78.2%, Underperform 5.9%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. NOTE: THIS IS A NEWS ONLY UPDATE. REST OF THE REPORT HAS NOT BEEN UPDATED YET. Canada and the U.S. The company owns approximately 10,700 miles of track with an additional 4,700 miles jointly owned, leased or operated under trackage rights. Of the total mileage operated, approximately 6,200 miles are located in western Canada, 2,200 miles in eastern Canada, 5,800 miles in the United States Midwest and 1,200 miles in the United States Northeast. Canadian Pacific serves the principal business centers of Canada from Montreal to Vancouver, as well as the U.S. Northeast and Midwest regions. The company has extended its network reach by establishing alliances and agreements with other Class I railways in North America, which allows it to provide services and access markets across North America beyond its own rail network. It also serves markets in Europe and the Pacific Rim through direct access to the Port of Montreal in Quebec, and the Port of Vancouver in British Columbia, respectively. Canadian Pacific derives revenues from Freight transport (accounted for approximately 98% of 2013 total revenue) and Other services (2%). Freight revenues are earned from transporting bulk, merchandise and intermodal goods, and include fuel recoveries billed to the customers. Freight segment consists of: Grain, consisting mainly of durum, spring wheat, barley, canola, flax, rye and oats, which are primarily transported to ports for export and to Canadian and U.S. markets for domestic consumption. The U.S. grain products mainly including durum, spring wheat, corn, soybeans and barley are shipped from the Midwestern U.S. to other points in the Midwest, the Pacific Northwest and Northeastern U.S. Equity Research CP Page 5

Coal consists primarily of metallurgical coal transported from southeastern British Columbia (BC) to the ports of Vancouver, BC and Thunder Bay, Ontario, and to the U.S. Midwest. The Coal business chiefly consists of transportation of thermal coal and petroleum coke within the U.S. Midwest. Sulfur and Fertilizers include potash, chemical fertilizers and sulfur shipped mainly from western Canada to the ports of Vancouver, BC, and Portland, Oregon, and to other Canadian and U.S. destinations. Forest products include lumber, wood pulp, paper products and panel transported from key producing areas in western Canada, Ontario and Quebec to various destinations in North America. Industrial and Consumer products include chemicals, plastics, aggregates, steel, mine, ethanol, and other energy related products (other than coal) shipped throughout North America. Automotive consists primarily of the transportation of domestic, imported and pre-owned vehicles as well as automotive parts from North American assembly plants and from the Port Metro Vancouver to destinations in Canada and the U.S. Intermodal consists of domestic and international (import-export) container traffic. The domestic business consists primarily of retail goods moving in containers between eastern and western Canada and to and from the U.S. The international business handles containers of mainly retail goods between the ports of Vancouver, Montreal, New York/New Jersey and Philadelphia and inland Canadian and U.S. locations. Other revenues are generated mainly from leasing of certain assets, switching fees, routine land sales and income from business partnerships. REASONS TO BUY We are encouraged by Canadian Pacific s healthy performance backed by volume addition, safety and efficiency along with cost metrics. Additionally, pricing above inflationary levels (3 4% yearover-year growth) is expected to aid the company s projected revenue growth of 6% to 7% in 2014. In the third quarter of 2014, the company witnessed record 40% growth in operating income on the back of higher shipments, cost efficiency, increased freight rates, lower pension expenses and favorable exchange rates. Further, Canadian Pacific remains committed to generating an operating ratio in the low 70s. Canadian Pacific also targets an operating ratio of 65% in 2014, way ahead of its initial target of 2016. To attain this, the company focused on upgrading its network capabilities by consolidating and repairing facilities that will enable it to operate longer and heavier trains, achieve higher car velocity as well as deliver on-time performance. The company is also building network for shipping frac sand, pipe and construction materials as well as other goods required for oil and gas shale production to benefit from the current boom in the energy markets. To support these developments, the company expects a capital expenditure of C$1.2 billion to C$1.3 billion in 2014. Over the long term, the company expects coal demand to remain a significant driver with substantial contributions from its metallurgical coal transportation deal with Teck Resources Limited. Despite some prevailing softness in the markets the company expects strong demand for Teck coal due to their diverse market base, their high-quality product and competitive cost position. The replacement of short-haul U.S. thermal coal with long-haul metallurgical coal is also likely to prove beneficial. Canadian Pacific also secured new businesses for shipping coal from Powder River Basin (PRB) Equity Research CP Page 6

through the Ridley Terminal. As a result, 80% of the company s coal transportation business comprises metallurgical coal, which reduces exposure to the current weakness in the domestic thermal coal market. Further, shipments for domestic fertilizers are also expected to improve given a strong crop season in North America. In addition, the company is likely to witness a rebound in potash shipment as international potash prices begin to stabilize and more favorable operating conditions are expected during the third quarter. In Industrial and Consumer products, the company projects significant revenue growth driven by demand in the oil and gas market, mostly in the Bakken oil sands transport business. The company is currently managing shipment for lighter Bakken crude and sees considerable volume growth in moving heavy crude. However, growth in other industrial products will depend upon GDP growth. We expect the Marcellus Shale natural gas production units, Alberta's Industrial Heartland area and Canada's largest hydrocarbon processing unit to support the company s revenue and market share gains in energy markets. Additionally, the company continues to develop facilities at Hardisty, Alberta, North Dakota and at New Town that are expected to carry higher volumes. These facilities add new capacity to the crude business, which will likely benefit the company making it less sensitive to crude spreads by balancing franchise. Further, the company stated that frac sand shipments from new mines will foster growth in this segment. Canadian Pacific s multi-year agreements with companies like Unimin Corporation, Smart Sand, Inc. and U.S. Silica, all of which deal in the energy market, also bode well for its long-term growth. In Automotive, the company expects to boost its shipments with a 5-year agreement with Canadian Tire Corporation for providing various supply chain solutions. In Intermodal, the company is likely to benefit from strength in the domestic segment based on the introduction of services. It expects to gain from the growth in long-haul shipments at the Port of Vancouver, which would largely offset the weaknesses in the Port of Montréal. Further, operational efficiencies and disciplined pricing would remain value additions for Intermodal services leading to profitable growth. In the Grain segment, the company expects strong demand in the U.S coupled with improved Chicago operating conditions that will offer opportunities for strong volume growth in eastern U.S markets, resulting in an estimated high single-digit year-over-year growth in the third quarter. The company remains focused on tapping domestic market opportunities through a number of ways. Canadian Pacific anticipates strong volumes from the Western coast of Canada along with robust demand from Thunder Bay area in the Eastern part. Canadian Pacific is also looking forward to its long-term deal with Cargill an international producer and marketer of food, to transport canola oil and meal from the facility in Camrose, Alberta. Canadian Pacific is strengthening its balance sheet by improving near-term liquidity with debt offering and pension prepayments. Last year, the company registered a 15% return on portfolio based on pension assets. As a result, it expects a pension income of C$52 million in 2014 versus an expense of C$45 million in 2013, which remains accretive to its cash flows. In addition, the company also projects an income of C$50 million in 2015 based on portfolios for pension assets. Going forward, Canadian Pacific seeks to reward its shareholders through increased dividend payments. Over the last couple of years, the company has increased its annual dividend by an average of 10%. In addition, the company also initiated a new share repurchase program of 5.2 million shares through Mar 16, 2015. We believe the increased share holder returns reflect the company s confidence in delivering strong earnings as economic growth accelerates. Equity Research CP Page 7

REASONS TO SELL The company s freight volumes and revenues are largely dependent upon the performance of the North American and global economies, which are still on the slow recovery path. We believe that the current turmoil in Iraq may negatively affect Canadian Pacific s petrochemical shipments, which is one of the key shipment commodities of the company. Moreover, near-term growth is expected to be tempered by lower coal production in the domestic market and lower international thermal prices. Lower natural gas prices resulting in weak thermal coal market have raised significant concerns limiting overall coal shipments, despite strong exports to Asian countries. Further, the company expects Intermodal revenues to be weak in 2014, given the loss of Orient Overseas Container Line business to Canadian National Railway Company. In Oct 2014, Canadian Pacific ended collaboration talks with CSX Corporation and plans no further discussion on it. It was a major blow to the company as it faces significant competition for freight transportation in Canada and the U.S., from other railways, trucking and barge companies. Hence, merger between the railway operators would have countered competition along with improving efficiency by means of developing a single railroad which would deliver coal from mines to utility centers, with fewer stops. In addition, most of the company s employees are represented by a labor union and are covered by collective bargaining agreements. Generally, these agreements are bargained nationally by the National Carriers Committee. In the rail industry, negotiations generally take place over a number of years. If Canadian Pacific is unable to negotiate acceptable agreements, it could result in strikes by the affected workers, leading to loss of business and increased operating costs as a result of higher wages or benefits paid to union members. The company is exposed to commodity risk related to purchases of diesel fuel and the potential reduction in net income due to increased diesel price. As fuel expense constitutes a large portion of the company s operating costs, volatility in fuel prices can have a significant impact on net income. However, the impact of fuel expense is mitigated substantially through fuel cost recovery programs, which apportion incremental changes in fuel prices to shippers through price indices, tariffs, and by contract, within set guidelines. The company s expenses could also be affected by an increase in stock-based compensation and long-term incentive compensation. Canadian Pacific operates in both Canada and the U.S. and is thus, affected by currency fluctuations. Changes in the exchange rate between the Canadian dollar and other currencies (including the U.S. dollar) make the goods transported by the company more or less competitive in the world market, thereby affecting the company s revenues further. The company is subject to the jurisdiction of various regulatory agencies, including the Surface Transportation Board (STB), the Federal Railroad Administration (FRA) and other state and federal regulatory agencies. New rules or regulations by these agencies could increase the company s operating costs or reduce operating efficiencies. For example, the Rail Safety Improvement Act of 2008 (RSIA) imposes limits on employee work hours which leads to higher operating costs for the company. The RSIA also mandated the installation of PTC (Positive Train Control) by Dec 31, 2015 on main lines that carry certain hazardous materials and on lines that involves passenger operations. The FRA issued its final rule in Jan 2010 on the design, operational requirements and implementation of the new technology. The final rule is expected to impose significant new costs for Canadian Pacific and the rail industry as a whole. Additionally, amendments brought in by the Congress or STB on regulating pricing policies for Class I freight rail transport companies (based on 2010 report presented by the U.S. Senate Commerce Committee) will create a significant headwind, especially when the economic uncertainty is hurting volume growth and pricing has become a dominant factor for revenues going forward. Equity Research CP Page 8