Business Context and Reporting Period
Company: Canadian National Railway Company (CN)
Filing Type: Form 6-K (Report of Foreign Issuer)
Reporting Period: Third quarter and nine months ended September 30, 2012
Business Overview: CN operates a network of approximately 20,000 route miles spanning Canada and mid-America, connecting the Atlantic, Pacific, and Gulf of Mexico. The company manages its operations as a single business segment, focusing on freight transportation across seven commodity groups.
Key Financial Metrics
| Metric | Q3 2012 | Q3 2011 | 9M 2012 | 9M 2011 |
|---|---|---|---|---|
| Revenues (C$ millions) | 2,497 | 2,307 | 7,386 | 6,651 |
| Operating Income (C$ millions) | 985 | 938 | 2,763 | 2,457 |
| Net Income (C$ millions) | 664 | 659 | 2,070 | 1,865 |
| Diluted EPS (C$) | 1.52 | 1.46 | 4.71 | 4.08 |
| Operating Ratio (%) | 60.6% | 59.3% | 62.6% | 63.1% |
| Free Cash Flow (C$ millions) | 333 | 505 | 1,036 | 1,328 |
| Total Debt (C$ millions) | 6,448 (as of Sep 30, 2012) | |||
| Cash & Equivalents (C$ millions) |
Note: Free cash flow for the nine months ended September 30, 2012, includes the impact of C$450 million in voluntary pension plan contributions made in Q1 2012.
Material Changes vs. Prior Period
- Revenue Growth: Q3 2012 revenues increased 8% year-over-year, driven by higher freight volumes (3% increase in carloads, 7% in revenue ton-miles), freight rate increases, and a positive translation impact from the weaker Canadian dollar. Petroleum and chemicals revenues led growth with a 15% increase.
- Operating Expenses: Expenses rose 10% in Q3 2012 to C$1,512 million, primarily due to higher labor and fringe benefits, increased purchased services, and volume-related fuel costs.
- Operating Ratio: The operating ratio increased by 1.3 points to 60.6% in Q3 2012 compared to 59.3% in Q3 2011. However, for the nine-month period, the ratio improved by 0.5 points to 62.6%.
- Unusual Items:
- 2012: Included a C$281 million pre-tax gain (C$252 million after-tax) from the disposal of the Bala-Oakville rail segment in Q1.
- 2011: Included a C$60 million pre-tax gain from the disposal of IC RailMarine Terminal assets in Q3 and a C$288 million pre-tax gain from the Lakeshore East disposal in Q1.
Guidance, Outlook, and Risks
- 2012 Guidance: CN remains comfortable with its full-year 2012 guidance, expecting up to 15% growth in adjusted diluted EPS over 2011 levels (C$4.84). The company expects to generate approximately C$1 billion in free cash flow for 2012, potentially including an additional C$250 million voluntary pension contribution in Q4.
- Capital Allocation: On October 22, 2012, the Board approved a new share repurchase program for up to C$1.4 billion (maximum 18 million shares). The company plans to invest approximately C$1.8 billion in capital programs for 2012, with over C$1 billion targeted at track infrastructure.
- Key Assumptions: Outlook assumes North American industrial production growth of ~3.0%, U.S. housing starts of ~750,000 units, and a Canadian-U.S. exchange rate near parity. Crude oil prices are assumed to average US$95 per barrel.
- Risks and Contingencies:
- Legal Proceedings: CN is involved in legal proceedings against its former CEO regarding the forfeiture of approximately C$18 million in RSU payouts and C$1.5 million in annual retirement benefits due to alleged breaches of non-compete and non-disclosure agreements. No gain has been recorded pending resolution.
- Pension Funding: The company faces a solvency deficit of approximately C$1.3 billion in its Canadian pension plans. Voluntary contributions of C$450 million in Q1 2012 are expected to cover special solvency payment requirements through 2014.
- Regulatory & Environmental: Risks include potential changes in economic regulation (e.g., STB proceedings on competitive switching), environmental remediation costs (C$126 million accrued), and labor negotiations.
Investor Verification Checklist
- Adjusted EPS: Verify the reconciliation of reported EPS to adjusted EPS, specifically the exclusion of the C$281 million Bala-Oakville disposal gain in 2012 and the C$60 million ICRMT gain in 2011.
- Pension Contributions: Confirm the impact of the C$450 million voluntary pension contribution on Q1 2012 free cash flow and the potential for an additional C$250 million contribution in Q4 2012.
- Share Repurchase Program: Review the terms of the new C$1.4 billion share repurchase program approved in October 2012 and its execution timeline.
- Legal Contingency: Monitor the status of the legal dispute with the former CEO regarding the forfeiture of benefits, which could result in a non-recurring gain if resolved in CN's favor.
- Foreign Exchange Sensitivity: Assess the impact of the Canadian dollar's fluctuation against the U.S. dollar, as a significant portion of revenues and expenses are USD-denominated.