CNI

Business Context and Reporting Period

Company: Canadian National Railway Company (CN)
Filing Type: Form 6-K (Report of Foreign Issuer)
Reporting Period: First Quarter ended March 31, 2011
Business Overview: CN operates a transcontinental railway network spanning Canada and mid-America, connecting the Atlantic and Pacific oceans to the Gulf of Mexico. The company serves major ports and metropolitan areas, providing freight transportation services.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Revenues increased 6% year-over-year, driven by higher freight volumes, rate increases, and fuel surcharges. This was partially offset by the negative translation impact of a stronger Canadian dollar.
• Volume and Yield: Carloadings rose 3% and revenue ton-miles increased 5%. Rail freight revenue per revenue ton-mile increased 2%.
• Profitability: Net income increased 31% to C$668 million. This includes a significant one-time after-tax gain of C$254 million from the sale of a rail line (Lakeshore East) to a Toronto-area transit agency. Excluding this gain, adjusted net income grew 9% to C$414 million.
• Operating Efficiency: The operating ratio improved by 0.3 points to 69.0%, despite higher fuel costs and depreciation expenses.
• Cash Flow: Free cash flow decreased to C$445 million from C$493 million in the prior year, primarily due to higher capital expenditures and dividends, though offset by proceeds from the rail-line sale.

Guidance, Outlook, and Risks

Revised 2011 Outlook

CN has revised its 2011 financial outlook upward based on strong Q1 results and improving economic conditions:

• Earnings: Expects double-digit diluted EPS growth of up to 15% on an adjusted basis, targeting C$4.83 (up from C$4.20 in 2010).
• Free Cash Flow: Revised full-year outlook to approximately C$1.2 billion, up from the previous C$850 million estimate. This reflects Q1 performance, rail-line sale proceeds, and a potential C$200 million voluntary pension contribution.
• Capital Investment: Plans to invest approximately C$1.7 billion in capital programs, with over C$1 billion targeted for track infrastructure.

Key Assumptions and Risks

• Economic Assumptions: Forecasts 4.5% growth in North American industrial production, 650,000 U.S. housing starts, and 13 million U.S. motor vehicle sales.
• Commodity Prices: Assumes crude oil (WTI) prices between US$100 and US$110 per barrel and a Canadian-U.S. exchange rate between C$1.00 and C$1.05.
• Risks: Key risks include general economic conditions, fuel price volatility, currency fluctuations, regulatory changes (including Positive Train Control implementation costs of ~C$200 million), environmental liabilities, and labor negotiations.

Investor Verification Checklist

• One-Time Gains: Verify the sustainability of earnings by excluding the C$254 million after-tax gain from the Lakeshore East rail-line sale when analyzing core operational performance.
• Currency Impact: Assess the sensitivity of future results to the Canadian dollar, as a stronger CAD negatively impacted reported revenues and net income in Q1 2011.
• Capital Expenditures: Confirm the execution of the C$1.7 billion capital plan, particularly the C$1 billion allocated to track infrastructure, to ensure network fluidity.
• Debt Management: Monitor the repayment of long-term debt and the utilization of the US$1 billion revolving credit facility, which had C$423 million in letters of credit drawn as of March 31, 2011.
• Environmental Liabilities: Review the C$147 million aggregate accrual for environmental costs and the potential for additional liabilities from unknown contamination sites.