New York New York USA - Canadian Pacific Railway Ltd. bondholders are signaling they're prepared to finance the company's coast-to-coast expansion plans.
 
Bond market reaction was muted to Canadian Pacific's merger proposal last week to CSX Corp. to create a railway stretching from Vancouver to South Florida.
 
Credit-default contracts on Canadian Pacific bonds settled yesterday were where they started the week.
 
Although Canadian Pacific's initial approach for CSX was rebuffed, bondholders rejected the idea that an acquisitive strategy by Chief Executive Officer Hunter Harrison will hurt them.
 
"I wouldn't envision anyone doing a deal that would threaten investment-grade ratings," Keith Hoppe, credit analyst at Thrivent Financial for Lutherans, which owns Canadian Pacific bonds, said yesterday by phone from Minneapolis.
 
"A deal that includes US$3 billion to US$4 billion of debt would be very easily financed and maintain their leverage target."
 
Yields on Canadian Pacific's 5.95 percent notes due May 2037 traded yesterday at 107 basis points, or 1.07 percentage points, relative to Treasuries, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
 
That was 10 basis points wider than a week earlier.
 
A Bank of America Merrill Lynch index of corporate bonds from U.S. and Canadian companies due in 15 years or more widened 10 basis points between 7 Oct 2014 and yesterday.
 
Default Swaps
 
The cost to protect the Calgary-based railway's bonds from default for five years closed yesterday at about 40 basis points, the same as on 10 Oct 2014.
 
Since Harrison took over in June 2012, Canadian Pacific has shed its status as the least efficient North American railroad.
 
Debt has fallen to about 2 times earnings before interest, taxes, depreciation, and amortization, from a leverage ratio of about 3 times Ebitda before his tenure, as profitability improved.
 
Canadian Pacific's bonds are the top performers in Bank of America Merrill Lynch's U.S. Transportation Index this year, generating a return of 13.5 percent through 13 Oct 2014.
 
Canadian Pacific "has a longstanding policy of not commenting on rumors and speculation," Marty Cej, a spokesman for the company, said by phone from Calgary yesterday.
 
Fredrik Eliasson, CSX's chief financial officer, declined to comment about a potential merger with Canadian Pacific in an interview on Bloomberg Radio yesterday.
 
"They made tremendous strides in improving their operations and that's benefited the bonds," said Hoppe, adding it's hard to find dealers willing to sell the securities on the secondary market.
 
Ratings Upgrades
 
Canadian Pacific was upgraded one level to BBB by Standard & Poor's on 16 Apr 2014 and to an equivalent Baa2 by Moody's 24 Apr 2014.
 
Both New York-based ratings companies have positive outlooks on the railway's $4.3 billion of bonds, according to data compiled by Bloomberg.
 
The Calgary-based railroad is targeting a BBB+ credit rating, Chief Financial Officer Bart Demosky told investors at a presentation in White Plains, New York, on 2 Oct 2014.
 
That's three levels above junk, and one level higher than the company's current ranking.
 
The company's debt is "quickly approaching" 2 times Ebitda, within its preferred range of 2 to 2.5 times, Demosky said.
 
"We do believe they are committed to maintaining leverage within that band," Darren Kirk, senior credit officer at Moody's in Toronto, said in a telephone interview yesterday.
 
"We'd like to see the operational improvements season out a bit before we get comfortable taking that rating up even though their financial leverage is consistent with a higher rating today."
 
Canadian Pacific's bond-implied rating is A3, or two levels higher than its current rating, according to Moody's Analytics.
 
Leverage Goals
 
Demosky also said the railroad has the capacity to take on as much as $6 billion in new debt to meet its leverage goals and preserve its credit rating.
 
The cash would be "available to return to shareholders," he said, adding that the company may accelerate a stock buyback program.
 
A lower rating would be "suboptimal" because it would prevent the company from tapping certain "low-cost" sources of financing such as U.S. commercial paper, the CFO said.
 
Canadian Pacific had long-term debt of $4.63 billion as of 30 Jun 2014, according to a 17 Jul 2014 filing.
 
That's down from $4.69 billion at the end of last year.
 
Canadian Pacific may persist on a deal with CSX or consider a new target, a person familiar with the matter who asked not to be identified because the talks are private, said 12 Oct 2014.
 
Dance Partners
 
"Would we ever consider anything? As I've said publicly before, sure," Harrison said in a 1 Oct 2014 presentation.
 
"But you got to have somebody to dance with, and I don't know anybody who wants to dance now."
 
He predicted a merger between two of the big North American railroads sometime in the next five years.
 
For cargo traveling between the coasts, a railroad spanning the width of North America would eliminate the need for competing railroads to hand off cargo in congested Chicago.
 
Long discussed by the railroad industry, east-west mergers haven't gone forward in the face of regulatory opposition.
 
Harrison, the former head of Canadian National Railway Co., was installed by Bill Ackman, the billionaire founder of New York-based Pershing Square Capital Management LP, after a proxy battle two years ago.

Cecile Gutscher and Frederic Tomesco.