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 rail network 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

Note: Adjusted figures exclude gains from rail-line sales. All figures in Canadian dollars unless otherwise noted.

Material Changes vs. Prior Period

• Unusual Items: Reported Net Income included a significant after-tax gain of C$254 million (C$0.55 per share) from the sale of the Lakeshore East rail-line segment to a Toronto-area transit agency. This non-recurring item drove the 31% increase in GAAP Net Income.
• Operational Performance: Excluding the rail-line sale, Adjusted Net Income grew 9% year-over-year. Revenue ton-miles increased 5% and carloadings rose 3%, driven by economic recovery and rate increases.
• Expense Drivers: Operating expenses increased 6% to C$1,439 million. The primary drivers were higher fuel costs (up 29% due to price and volume), increased purchased services, and higher depreciation. These were partially offset by lower casualty and other expenses.
• Currency Impact: A stronger Canadian dollar negatively impacted reported revenues and net income. On a constant currency basis, Q1 2011 Net Income would have been C$9 million higher.

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 vs. C$4.20 in 2010).
• Free Cash Flow: Revised upward to approximately C$1.2 billion (from C$850 million), reflecting Q1 performance, rail-line sale proceeds, and a potential C$200 million voluntary pension contribution.
• Capital Spending: Plans to invest approximately C$1.7 billion in 2011, with over C$1 billion targeted for track infrastructure.

Key Risks and Contingencies

• Regulatory: Ongoing oversight by the U.S. Surface Transportation Board (STB) regarding the Elgin, Joliet and Eastern (EJ&E) acquisition, including grade separation commitments totaling C$165 million. Potential legislative changes to antitrust exemptions and economic regulation in the U.S.
• Environmental: Liability for approximately 300 sites with potential contamination. Aggregate accruals for environmental costs were C$147 million as of March 31, 2011.
• Legal: Aggregate reserves for personal injury and other claims were C$340 million. Final outcomes of pending litigation cannot be predicted with certainty.
• Operational: Risks related to fuel price volatility, labor negotiations (though Canadian agreements were recently ratified), and severe weather disruptions.

Investor Verification Checklist

• Adjusted vs. GAAP Earnings: Verify the sustainability of earnings growth by analyzing Adjusted Net Income (C$414M) versus GAAP Net Income (C$668M), noting the C$254M one-time gain.
• Constant Currency Trends: Review constant currency metrics to assess organic growth independent of the strengthening Canadian dollar.
• Debt Reduction: Confirm the trend in long-term debt reduction (down to C$5.45B) and the impact on the adjusted debt-to-EBITDA ratio (1.63x).
• Capital Commitments: Assess the impact of the C$165 million EJ&E mitigation commitment and the C$200 million Positive Train Control (PTC) implementation cost on future cash flows.
• Pension Funding: Monitor the potential C$200 million voluntary pension contribution and its effect on the revised free cash flow guidance.