UPDATE 4-CP Rail cuts guidance as fuel prices hit profits

(Adds analyst comments, closing stock price)

By Allan Dowd

VANCOUVER, British Columbia, July 22 (Reuters) - Canadian Pacific Railway Ltd (CP.TO) cut its earnings guidance for the third time this year, as fuel bills and U.S. flooding caused it to report a nearly 40 percent drop in second-quarter profit on Tuesday.

Canada's second biggest railway trimmed its expected earnings for 2008 by 40 Canadian cents a diluted share to a range of C$4.00 to C$4.20, and said the U.S. economy appeared unlikely to improve in the second half of this year while fuel costs would likely remain high.

Chief Executive Fred Green said the company, which also cut its earnings guidance slightly in February and after the end of the first quarter, could not get a "into a routine (of) hoping the economy will pick up, and building a business case around that."

"What we're doing is saying we accept (the economy) for what it looks like out the door. If it gets better, great news, but we have to plan for the possibility that it will (continue) or possibility deteriorate," Green said.

Canadian Pacific's shares closed off C$2.33, or 3.5 percent, at C$64.30 on the Toronto Stock Exchange.

But an analyst cautioned against reading too much into the company's need to revise its guidance again, since few people had predicted that fuel prices would rise so high or so fast this year

"One thing that is abundantly clear for CP ... is that their (fuel) surcharge system was not designed for the kind of escalation in fuel prices we have seen in the last six months," said Randy Cousin of BMO Capital Markets.

CP Rail executives said about 30 Canadian cents of the guidance cut was due to higher fuel costs, and even with the weak economy it expects its own shipping volumes to increase in the fourth quarter with wheat and other bulk commodities.

FLOODS WASH AWAY SOME PROFIT

Canadian Pacific earned C$154.9 million, or C$1.00 a share, on revenue of C$1.22 billion during the second quarter through June 30. That compared with a profit of C$256.7 million, or C$1.64 a share, on revenue of C$1.215 billion a year earlier.

Analysts, on average, had expected earnings of 99 Canadian cents a share, on revenue of C$1.25 billion, according to Reuters Estimates.

The company's operating expenses increased 7 percent, leaving it with an operating ratio of 79.4 per cent compared with 74.7 per cent a year earlier. The ratio would have shown little change without the fuel bills and flooding in the U.S. Midwest, company officials said.

The overflowing rivers blocked CP's line from Minneapolis to Chicago for 20 days during the quarter, forcing it to reroute or cancel the 20 trains that use the route daily.

Green has also appointed a senior executive to speed up CP's efforts to introduce technological, operational and maintenance changes that the railway believes will increase efficiency.

($1=$1.01 Canadian) (Reporting by Allan Dowd and Jennifer Kwan; editing by Rob Wilson)