Business Context and Reporting Period
Company: Canadian National Railway Company (CN)
Filing Type: Form 6-K (Report of Foreign Issuer)
Reporting Period: Second Quarter and First Half ended June 30, 2011
Business Overview: CN operates a transcontinental railway network spanning Canada and the mid-section of the United States, connecting the Atlantic, Pacific, and Gulf of Mexico. The company reported solid performance driven by improved freight volumes and operational execution despite weather challenges including floods and forest fires.
Key Financial Metrics
| Metric (CAD Millions) | Q2 2011 | Q2 2010 | YTD 2011 | YTD 2010 |
|---|---|---|---|---|
| Revenues | $2,260 | $2,093 | $4,344 | $4,058 |
| Operating Income | $874 | $813 | $1,519 | $1,416 |
| Net Income (GAAP) | $538 | $534 | $1,206 | $1,045 |
| Adjusted Net Income | $578 | $534 | $992 | $914 |
| Diluted EPS (GAAP) | $1.18 | $1.13 | $2.63 | $2.21 |
| Adjusted Diluted EPS | $1.26 | $1.13 | $2.16 | $1.93 |
| Operating Ratio | 61.3% | 61.2% | 65.0% | 65.1% |
| Free Cash Flow (YTD) | $823 | $958 | $823 | $958 |
Liquidity and Debt:
- Cash and Cash Equivalents: $175 million as of June 30, 2011 (down from $490 million at Dec 31, 2010).
- Total Debt: $5,962 million carrying amount (Long-term debt of $5,432 million + Current portion of $530 million).
- Debt-to-Total Capitalization: 34.2%.
- Credit Facilities: Entered into an $800 million revolving credit facility in May 2011; no outstanding borrowings under this facility as of June 30, 2011.
Material Changes vs. Prior Period
- Revenue Growth: Q2 revenues increased 8% to $2,260 million, driven by higher freight volumes, fuel surcharges, and rate increases. This was partially offset by the negative translation impact of a stronger Canadian dollar.
- Volume Increases: Carloadings rose 4% and revenue ton-miles increased 5% year-over-year. Intermodal volumes were a standout, rising 10% with revenues up 14%.
- Expense Pressure: Operating expenses increased 8% to $1,386 million, primarily due to higher fuel costs (average price $3.42/gallon vs $2.60 in 2010), increased purchased services, and labor costs.
- One-Time Items:
- Tax Impact: A net deferred income tax expense of $40 million ($0.08/share) reduced GAAP net income due to state tax rate changes.
- Asset Disposal: A gain of $288 million (after-tax $254 million) was recorded from the sale of the Lakeshore East rail property in March 2011. This is excluded from Adjusted Net Income.
- Currency Impact: On a constant currency basis, Q2 net income would have been $14 million higher due to the strengthening Canadian dollar.
Guidance, Outlook, and Risks
2011 Financial Outlook:
- EPS: Expects double-digit adjusted diluted EPS growth of up to 15% for 2011 (targeting ~$4.83 based on 2010 adjusted EPS of $4.20).
- Free Cash Flow: Expects approximately $1.2 billion for the full year, accounting for a potential $200 million voluntary pension contribution.
- Capital Investment: Plans to invest approximately $1.7 billion in capital programs, with over $1 billion targeted at track infrastructure.
Key Assumptions:
- North American industrial production increase of ~4.5%.
- U.S. housing starts of ~650,000 units and motor vehicle sales of ~13 million units.
- Canadian-U.S. exchange rate range of C$1.00 to C$1.05.
- Crude oil (WTI) price range of US$100 to US$110 per barrel.
Risks and Contingencies:
- Legal and Environmental: Aggregate reserves for personal injury and other claims are $339 million. Environmental accruals total $132 million for approximately 300 identified sites.
- Operational: Risks include severe weather, labor negotiations, fuel price volatility, and regulatory changes (e.g., Positive Train Control implementation costs estimated at $193 million).
- Guarantees: Maximum potential liability under standby letters of credit and other guarantees is $477 million.
Investor Verification Checklist
- Adjusted vs. GAAP: Verify the impact of the $40 million deferred tax expense and the $288 million asset disposal gain on reported earnings versus adjusted performance.
- Currency Sensitivity: Assess the impact of the strengthening Canadian dollar on future U.S.-denominated revenue translation.
- Fuel Costs: Monitor the trajectory of diesel fuel prices, which significantly impacted operating expenses in Q2.
- Intermodal Growth: Confirm the sustainability of the 10% volume growth in the Intermodal segment, which is CN's largest revenue driver.
- Cash Flow Usage: Review the $747 million spent on share repurchases in the first half of 2011 and its impact on liquidity relative to the $823 million free cash flow generated.